By Ben Gordon
To respond, typically you would undertake a review of the financial results and background of the business. This would then followed by valuing the business using a traditional earnings based methodology, such as the Capitalisation of Future Maintainable Earnings.
All going well, this process will confirm that the price your client is paying is within a reasonable range. But what if the purchase price is much higher than your value? The reasons for this are usually one or more of the following:
- the client is paying a premium for synergies of operation;
- the client has a personal attraction to the business in a “happy to pay over the odds just to get it” scenario;
- very strong demand in the industry at the time for that type of business
- a “rule of thumb” valuation approach has been adopted e.g. the price is a multiple of revenue;
- the client has had regard to apparently similar sales transactions;
- there are benefits of ownership that you haven’t considered; and/or
- the price is determined as a multiple of a return to the owner, including their labour worth.
In any of these circumstances it is important to understand how the client has calculated the business’ purchase price.
It may be the case that your calculations of value do not recognise either the “true profit” or all the benefits of owning the business, and should be revised.
If the client has based the value on a similar transaction, ideally you need to understand that “similar transaction”. Our experience is that apparently comparable sale values can be inflated through purchase prices reflecting earn outs, synergies, and substantial restraint of trade provisions.
It may be that the only genuine support for the Business’ sale price is a Rule of Thumb measure. That being the case, you need to understand that Rule of Thumb and check whether the client has applied it correctly. We have seen numerous occasions where a business value has been inflated simply because a client misunderstood a Rule of Thumb.
Ultimately, a key outcome is for your client to understand the risks underlying the Business’ value (for example, if a Rule of Thumb was to no longer apply in the future, they may not have a saleable business – or certainly not at a price comparable to what they paid for it). The client may still wish to proceed with their purchase, but will then be well informed as to the ongoing risks to value if they do.
An Important Message
While every effort has been made to provide valuable, useful information in this publication, this firm and any related suppliers or associated companies accept no responsibility or any form of liability from reliance upon or use of its contents. Any suggestions should be considered carefully within your own particular circumstances, as they are intended as general information only.