Selling a business has two crucial elements - finding potential buyers and negotiating a price. It's essential to make your own estimate of value at an early stage so that you are clear about the value you can expect to realise and the most appropriate methods to manage the sale.
This guide explains the key factors affecting the value of your business, and the different ways a value can be calculated. It also explains how to find potential buyers and how to approach them.
Key factors affecting the value of your business
There's a range of key factors that can affect the value of your business.
- Historical, current and projected profits and cash flow
- How well you control costs
- State of the economy in general and your market in particular
- How similar businesses are being valued
- How many potential purchasers are interested in the business
- Goodwill and intellectual property such as patents
- Strength of customer relationships - and how profitable they are
- Your business' growth potential
Assets and liabilities
- Value of assets such as property, equipment, debtors and stock-in-hand
- How full your order book is
- Level of debt and other existing liabilities
- The management's record of success
- How dependent the business is on your own skills - and the likely extent of your future involvement
- Experience and commitment of key staff
While some of these factors are outside your control, you can take steps to make your business as valuable as possible. You need to start planning well in advance.
Consider inserting an exit strategy into your original business plan
Remember that any valuation you and your advisors come up with is likely to be subjective. Business owners often place too high a value on their business. In the end, the value of your business is only as much as a purchaser is prepared to offer.
Common methods of valuing a business
There's a range of ways to value a business. Valuations based on multiples of future earnings and the capitalisation of future cashflows are the most common. There are a number of common valuation methods:
- Businesses with a record of sustainable profits are often valued at a multiple of earnings. Profits are adjusted for any unusual, one-off items to arrive at an estimate of "normalised" earnings. Smaller businesses are usually valued at a lower multiple than similar, larger companies.
- Mature, cash-generating businesses can be valued in a similar way but based on cash flow. Future cash flows are estimated and discounted - this is known as discounted cash flow. Long-term cash flow is worth less than cash flow due shortly.
- An asset valuation might be appropriate for stable businesses with significant tangible assets - property or manufacturing businesses, for example. Your starting point is the value of assets stated in the accounts known as the "net book value". These figures are then refined to reflect factors such as changes in the value of assets or bad debts.
- The cost of creating a business similar to yours can be used as a basis for valuation. Costs could include buying equipment, employing staff, developing products, attracting customers, and so on. It may be possible to estimate this "entry cost" as a benchmark of your business' value. Of course, if the cost of entry is low there's little likelihood of you achieving a successful sale.
- In some industries, there are established criteria for valuing businesses, e.g. by the number of branches a real estate agency has.
A potential buyer may use more than one method to get a range of values for your business. In the end, however, any price will be a matter for negotiation.
Prepare a sales memorandum
The sales memorandum is the initial marketing document you use to spark interest in your business. Your corporate finance advisor, if you have one, helps produce this as a key task in selling your business.
The sales memorandum provides potential purchasers with basic information about the company and what the sale might include. It should contain details of:
- Which industry your business is involved in and how long you have been trading
- Key financial figures such as profit, cash flow, value of assets and total debts
- Similar financial figures for previous years and how they have changed
- Number of employees and location of premises
If there are any special features of your business, they need to be highlighted. For example: "Our unique patented product is the Canadian market leader".
The sales memorandum should of course be truthful but present the business in as positive a light as possible. You should highlight any opportunities for growth or profit improvement. The aim is to interest potential purchasers, so that they want to know more.
The document shouldn't include confidential information such as names of customers or your pricing structure. You can reveal more detailed information later on in the process of marketing your business, when you've had a chance to gauge how serious prospective purchasers are. See the page in this guide on how to approach potential buyers.
Target the most likely buyers
Target those who you think would be prepared to pay a good price for your business because:
- You're the market leader in a particular segment - a competitor might want access to your customers so they can cross-sell their products
- You may have a product that fills a gap in their product range
- They might be able to use your distribution channels to sell their product range
- They might benefit from economies of scale in areas such as purchasing, production and sales
- They might want access to your people and skills
- You can show an excellent potential for growth
- A foreign company might want to expand into the Canadian market
At the same time, you want to be sure that any potential purchaser is serious. Crucially, you should satisfy yourself that they would be able to afford to buy your business. Your advisors should be able to help you establish this.
Good sources of potential buyers
Potential purchasers of your business are likely to come from a number of key sources:
- Your own knowledge of your sector should mean you know whether any of your competitors, customers or suppliers would be interested in buying your business.
- Trade magazines, business directories and the financial press may provide you with ideas.
- Your existing management team may be interested – but you'll need to be sure they can raise the necessary finance.
- Your corporate finance advisor should be able to help you identify possible buyers, both in Canada and abroad. They will have access to databases of prospective purchasers as well as an extensive network of contacts. For example, they may be able to advise you on equity investors or management buy-in teams who might be interested. They will also be able to help you assess whether buyers are capable of funding a purchase.
- For certain types of business it can be worth advertising for potential buyers.
Together with your advisor, you should draw up a shortlist of potential purchasers to approach. It can be a good idea to split this into two - a list of favoured prospective buyers you'll approach first and a back-up list if this doesn't produce results.
It's important that you don't focus all your efforts on a single prospect. If the buyer knows they are the sole interested party, they can call all the shots.
Approach potential buyers
Most sellers prefer to approach potential buyers through their advisor to help maintain confidentiality. Knowing that the business is for sale could upset your customers and employees. Competitors may also try to use the sale to find out your trade secrets.
Using your advisor also leaves you free to concentrate on running the business. Remember that the time taken up making initial contact with and providing further information to buyers can be significant.
The advisor starts by sending the sales memorandum to a shortlist of potential buyers. Before giving them any more information, the advisor assesses how serious they are. Your advisor may try to keep your identity secret in the early stages.
Prospective buyers are usually asked to sign a non-disclosure agreement. They agree not to use or pass on any information they find out about your business.
Once buyers are seriously interested, they usually want to meet to ask more questions. Your advisor may ask them to make an opening offer before they meet you.
After this, you become involved in more detailed negotiations.
Original document, Value and market your business, © Crown copyright 2009
Source: Business Link UK (now GOV.UK/Business)
Adapted for Québec by Info entrepreneurs