Corporate Finance Associates Blog

The content of the following post came about because as more and more lenders seem to ignore any business element involved when valuing their prospective security, often on a bricks and mortar basis or as an investment proposition taking into account either the lease that is in place or assuming that one is set up.

Businesses are changing hands very regularly and some lenders are now at least valuing the business as a ‘going concern’ as opposed to the two methods mentioned above which does allow some flexibility, but how is a business valued especially if it is up for sale?

Well the following information was kindly provided by one of our associate companies (we aren’t called ‘Corporate Finance Associates’ for nothing).

Thanks here go to Roger Smith of Stirling Business Transfer Specialists because this company really understands this sector and maximising the value when a business is put up for sale, we just pick up the other side and work with the prospective purchaser.  Do follow the link to Stirling at the foot of this post for further information.

Valuing a Business

When it comes to valuing a business, we need to realise that businesses are all as different as the people who run them. They each have their own peculiarities and way of doing things. This makes it very difficult to compare any two businesses.

What we can do is consider how much each business is worth, or what someone might be prepared to pay for it. There are a number of reasons why business valuations need to be carried out; it might be that someone is considering selling part or all of it, or that someone is interested in purchasing the business. It might be for matrimonial purposes, the drawing up a will, or it might just be because the owner wants to know what he or she is worth. There are almost as many reasons for wanting to know the value of a business, as there are businesses.

Valuing a business is not always a straight forward process as it will depend on the type and size of the business and there are at least 5 difference valuation methods. On occasions, it may be necessary to use more than one method in order to arrive at a realistic figure. The most common methods are as follows:-

1.         Total Assets
This method is more appropriate for established companies with large amounts of tangible assets. 

2.         Earnings Multiples or Price/Earnings Ratio
P/E ratios are used to value companies with an established profitable history. Quoted companies generally have a higher P/E ratio. A typical P/E ratio for a large growing quoted company with excellent prospects might be in the region of 15 to 20. Quoted company shares are much easier to buy and sell which makes them more attractive to investors than shares in comparable unquoted companies. Typically, the P/E ratio of a small unquoted company is up to 50% lower than that of a comparable quoted company in the same sector. But valuable intangible assets can improve the ratio somewhat.

3.         Entry Cost
This is the predicted cost to set up a similar business to the one being valued. This method of valuing the business would include the cost of developing a customer base and reputation, recruiting and training specialized staff, purchasing assets and licences and developing products and services.

4.         Discounted Cashflow
This method uses an estimate of the company’s cash-flow over say a five year period. The terminal value of the company is also calculated after this period of time has expired. The value of the predicted cash-flow, plus terminal value, is then discounted to provide a current business valuation. It may be hard to establish the terminal value as it relies so heavily on the cash-flow estimates. This method of valuing the business could be relevant for businesses with lots of potential, but few assets.   A discounted cash-flow calculation is a complex valuation that requires a great deal of information to reach a reasonable valuation.

5.         Industrial Sector Rule of Thumb
In certain industries, when company’s change hands on a regular basis, industry wide rules of thumb are sometimes used to value a business. These include accountancy firms and solicitors, (who like to have their own way of doing things!), recruitment agencies etc

To visit Stirling’s website if you have a business to sell follow this link.

And if you are looking to buy one contact us here.

With more and more big name lenders failing to deliver the funding solutions that they tell the media they are, project Merlin for example is running significantly behind the government’s set target, they can be accused of being guilty of one major thing, namely NOT feeding back the reason why they cannot help.

One of the factors is what we often describe as an ‘Exit Strategy’, with some lenders being solely focussed on the ‘Exit’ to the borrowing, and nowhere is this more apparent than the secondary and tertiary lenders that have swept in to fill some of the void left by the High Street.  They are looking at the ….what if it goes wrong …. Scenario and more often than not relying on their valuers to produce a 90 day valuation report, having no regard to current Market Values.  The 90 day figure can best be compared to the old ‘Forced Sale Value’ and that illustrates exactly what it is.

Many of the enquiries we receive however have not grasped the concept that even if the Loan to Value is low, if the business doesn’t have an ‘Exit Strategy’ in mind why should a short term funder put their money in if the future for repayment is woolly.

Short term funding is in a lot of cases the most appropriate way forward in the absence of High Street support, perhaps for 1-3 years with the aim of refinancing after that time when hopefully the current credit conditions have eased.  These lenders want to know their way out though.

Now there is essentially only two exits, a sale of the asset, or a refinance, so short term funders are going into greater background detail to satisfy themselves that the borrower will have the wherewithal at the end of the term to refinance, or that the marketing to sell is realistically being approached.

So in the absence of the High Street changing their approach any time soon, they always were ‘Glass Half Empty’ institutions anyway, prospective borrowers need to think long and hard about how they can get out of a loan, even before the new lenders will let them get in.

So it is always about showing these new lenders the door (your exit) and hopefully they won’t be showing you theirs.

Looking at the various press items over the past week we learn that credit and debit card fraud is falling but that identity theft is becoming more sophisticated and we are warned within an inch of our lives that there are enough people out there looking to steal our identity and have their way with our details to make us almost paranoid.

Well thankfully no one has stolen my identity and I religiously dispose of all personal and sensitive correspondence in the best way I know – it makes great fire lighters – but this week I realised that I almost don’t exist.

Why….. well my passport expired in December and as we didn’t take our usual winter holiday I overlooked sorting out a replacement, so guess what, solicitors acting for our business wanted proof of my ID as a new client to their firm, and I didn’t have any!

“Can you let us have a copy of your photo driving licence?” I was asked – No, I still have a paper one issued in 1978 with the two minor hiccoughs for speeding in the 80’s and 90’s.  Having not moved house, there has never been a need to change – what else could I use?

Now we are no different as an organisation in that we need to ‘Know our Client’ so I know what is required, but since I have never been in a trade union, worked for an employer for the last 21 yrs, or shot bright orange bits of clay out of the sky for the past 10 years I don’t have anything with my picture on any more, so a bit of frantic searching came up with some alternatives, at least I wasn’t trying to borrow money, they would have wanted loads more.

There is a generation out there for which identity documentation is almost non- existent, my parents have no passports, the solitary bank card, no mobile phone or regular pc access, no photo cards at all and the challenges they have had giving a bank their money to look after has been horrendous, I hope I am not getting like them.

So this week I will mostly be getting myself a new passport, because you never know a lottery win this week might force me into going on holiday before Easter, and I don’t want to be held up.