There has been a high level of merger & acquisition (M&A) activity in Australia recently and this means it is particularly timely to have a good idea of a business’s value.
Many organisations are looking for opportunities to expand and, while business owners may have no current plans to sell, an offer that is too good to refuse could be knocking on the door. But how does a business owner know what is too good to be true if they do not understand the value of their business?
The perceived value of a business is likely to vary significantly depending on whether you are the buyer or the seller.
It is not uncommon for a business owner to have an opinion on the value of their business. It is common however for a business owner to not be able to provide commercial validation to support their opinion.
A buyer however is likely to have an anticipated return on investment requirement thus will value the business based on sustainable profit and by applying the rate of return requirement. If the potential buyer is a competitor or in a similar industry the sustainable profit may be significantly higher if the business was merged into the buyer’s business due to a broad range of business synergies.
Another trigger for valuing a business is that the owner is getting ready to retire. But it’s not always possible to plan ahead, and other unexpected reasons, such as death, illness, divorce or bankruptcy, can also trigger the sale of the business.
It’s therefore worthwhile to have a business ready for sale at all times. This includes ensuring sustainable profit from one year to the next is optimised, as that is what prospective buyers would be seeking, as well as having reliable financial accounts, systems and processes, and understanding the business and the trading environment.
A key element of business valuation is sustainable profit/return on investment into the future. When economic conditions are uncertain, this can make valuations more difficult to assess.
A reasonable estimate of market value requires skill, knowledge and experience. Several valuation and accounting professional bodies and institutes provide certification and standards for valuers.
An experienced business valuer with commercial acumen can navigate all the nuances to ensure that the purpose of the valuation is appropriately considered. An example might be where a significantly higher-than-market price was negotiated for a business, however, the capital gains tax was determined with reference to an appropriate market value.
It can also make good sense to value a business regularly, such as once a year. Once a valuation has been undertaken the first time, the same bases and assumptions can be used each year. This creates a benchmark valuation process so that the factors affecting the performance can be highlighted and evaluated on a regular basis.
Business valuations are often required to support the submissions made to the Australian Taxation Office (ATO) relating to the sale or purchase of business assets. While a valuation is an estimate of an asset’s value, the valuation must be based on the most relevant and reliable information that is known or could reasonably be foreseen, at the valuation date. The ATO have some specific requirements for valuations so having an ATO-compliant business valuation is important.
Business owners should always strive to maximise sustainable profits, improve systems and processes and try to ensure they enjoy the fruits of their labour, even though their business may not technically be for sale.
It is common for people selling a house to fix all the little things that didn’t work properly and then realise that had they done that along the journey they would have enjoyed the house so much more and may in fact not necessarily want to sell. Business can be the same.
This article was first published in the Autumn 2024 issue of Financial Times.