A business is only worth what you’re prepared to pay for it. But buyers are in danger of being ripped off without proper checks – CPA Australia studies show more than 80% of potential buyers would have paid too much for their business if they hadn’t carried out financial due diligence.
To independently gauge a valuation, consider tangible and intangible factors – goodwill among customers and the community, ongoing contractual work, intellectual property and equipment and premises.
“Business value will normally be measured by either its level of profitability, a value model specific to your industry or, in a very limited number of cases, a value attached because of the future potential of your business,” explains Greg Hayes, of business advisory firm Hayes Knight.
“Some industries have a specific industry valuation model. Typically these occur where there are a large number of participants.”
“Think about an industry or sector where you have a large number of similar type businesses and where the business model is reasonably consistent. Businesses like newsagents, pharmacies, cafes, real estate agents are examples of these businesses, and there are many more.”
“The good thing about these businesses is that value is relatively predictable.”
Peskett adds: “Make sure the value is transferable, not just retained all in goodwill. Are the systems and processes that the business has been built on documented and able to be followed by someone new or is it all tied up in the knowledge and relationships of the previous owner?”
“Does the business actually own the IP that you wish to acquire or is it licensed from a third party? Is the licence transferable?
Before you spend your money, you need to be certain exactly what you’re buying. Will you be purchasing the business entity or just its assets?
Once you do so, will you operate as a company, sole trader, partnership or trust? Will there be a cooling off period?
These are all questions you need to grapple with. Peskett says that it’s important to identify the level of liability you’re taking on.
“Buying the entity means you acquire its risks and liabilities such as debt, previous trading history, tax liabilities and responsibility for responding to customer action against faulty products or services,” he says.
“Will the warranties and indemnities of the business hold up against this? If not, buying the assets only might be a consideration as this generally carries less risk.”
Focus on future profit, growth and cashflow. Is this business really one that will provide you with a springboard into bigger and better things?
Further to that, are the people in the business prepared to work for you? Will valued customers be perturbed by an ownership change? Do you need to shake up the culture of the business when you arrive?
Clearly work out what kind of boss you intend to be and how your arrival will impact the status quo.
Also, you need to be aware of the business’ reliance on its owner-operator. You may be stepping into a brand that was essentially modelled around one person, who has now left.
“If this business is reliant on the owner-operator, then it limits the potential owners to those that possess the key skills required by the owner-operator,” the BizExchange Index report points out.
“They will bring with them a perception of the value difference between their skills and those of the current owner-operator.”
“As such, this value will be highly subjective and the departing owner-operator is stuck between a rock and a hard place.”
“He needs to show that he has a business that is well run with a good reputation, at the same time as presenting a business that has the potential to be run better and go further with the new owner.”
“As a general rule of thumb, the less a business is reliant on the owner-operator, the higher the value of the earnings multiple.”
