When the owners of private businesses in Orange County finally make the decision to sell their business, the first question on their mind is “what is the value of the business” when it goes to market. Reality is that the market place will determine the actual value of the business. It is not a perfect market and five different buyers will bring five different offers as each buyer will assess the risk associated with future earnings differently. The predictability of earnings going forward is critical to the valuation of the business but the certainty of the forward looking earnings is subject to risk. The buyer will consider each of the following aspects of the business to determine the risk;
1. Business Model
2. Uniqueness in the market
4. Competition in market and reputation of business
5. Management in place and their strengths
6. Gross Profit Margins
7. Operation Strengths and Weaknesses
9. Asset Strengths
10. Customer Concentation
11. Barriers to entry
12. Intangible Assets
13. Size of business. Size does matter
14. Financial Performance (past and projected)
These issues contribute to a company’s risk profile which will impact the multiplier of pre-tax earnings used to determine value.
Ultimately a buyer looks at valuing a business based upon “return on investment” (ROI). A buyer looks at the value of a business by determining a reasonable rate of return based upon the risk. Buyers looking for a low risk might be happy with a 5%-10% ROI. Buyers with a higher risk tolerance might go for 30%-50% ROI because of the risk involved. Privately held companies would generally be considered in the middle to high risk part of the scale. Expected annual returns for these acquisitions would be in the 15%-30% range. Valuation if determined by dividing the expected rate of return by 100%. For example, if a buyer wants a 20% return, then the multiple will be 5. (100% /20%=5). The multiplier times the recast profits equal enterprise value for the business. Why so some businesses have a value based on a multiple of 2 or 3 while other businesses have much higher multiples (5-6 ). Low multiples may apply when a buyer is buying a job. Much higher multiples apply to larger companies with much lower risk, proprietary products or processes, intangible assets no reflected on the Balance Sheet or increasing earnings.
Empire Business Solutions offers a free Broker Opinion of Value for owners who want to look at selling their business in Orange County.