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The sale of a business is generally one of the most important transactions of an entrepreneur’s life, and often, the most complicated. Moreover, when this is a family transfer, the transaction could be even more sensitive, given the emotional aspects involved that can influence the sales price.
In any business transfer, “the” big question that keeps coming back is: “How much is my company worth?” The challenge is to determine a price that reflects the fair value of the SME, which satisfies both the transferor and transferees, and that ensure the business’s longevity.
This is why it is essential to establish the business’s value with a thorough, objective and structured process.
Avoid conflicts
For entrepreneurs who dedicate their lives to building their SME, transferring it can be a painful, emotionally charged experience. Also, as they rely on the proceeds from the sale to fund their retirement, in their eyes, their business is worth a lot of money…sometimes more than its fair value.
If they have children, entrepreneurs usually want them to take over the business, but this is where two perspectives and two realities may collide. On one hand, entrepreneurs want to get the most money possible for their SME. On the other hand, the acquisition of the family business is a major investment for the children; do they have the financial means? For the children, the value of the business equals their ability to pay.
These issues could cause resentment and tensions within the family. Using the services of an expert who can give transferors and transferees a fair and neutral opinion about the value of the business, can reduce the risk of conflicts. Furthermore, this ensures a fair treatment for the children who will not be involved in the business after the transfer.
Main traps to watch out for
Business valuation can include several traps. How many times have we heard entrepreneurs propose unbelievable amounts about the value of their SME!
Numerous entrepreneurs tend to use a market-based valuation method. One of the most popular calculations, based on transactions of comparable businesses, consists in multiplying earnings before interest, taxes, depreciation and amortization (EBITDA) by a multiplication factor.
The problem is that transferors tend to overestimate this factor, by relying on hearsay because it’s difficult to obtain reliable information about comparable transactions. In fact, unlike real estate transactions, there is no register where the sale prices of businesses are recorded.
Instead, business valuation experts prefer a performance- or earnings-based valuation method, which essentially relies on the business’s ability to generate earnings. This method therefore procures a more precise measurement of the SME’s fair value.
A few other key points to consider when evaluating a business
- Don’t forget any assets or liabilities.
- Take into account capital investments required to support the business’s activities.
- EBITDA does not include interest on debt. Therefore, don’t forget interest-bearing debt in the calculation of the business’s value.
- Consider unusual salary adjustments and performance bonuses that might have influenced EBITDA in the course of the last year.
- Do not count the economic benefit for the business of owning a building twice. If you assess based on earnings and the business owns its building, the economic benefit of this asset is already included in earnings (since the business does not pay rent). Don’t duplicate its value by adding the building’s value to that of the business’s activities.
- Take the time to perform a due diligence review before buying a business, that is, one that draws up a detailed portrait of the company’s financial, commercial, legal and operational aspects.
One last tip
Above all, do not try to sell the business to your children if they don’t have the financial ability to buy it at its fair value. Consider other solutions that would benefit all. For example, you could use the proceeds from the sale of your SME to help your children start up a new business or invest in other projects with them.
Would you like more information about the business valuation process? Don’t hesitate to contact our experts. They will be pleased to help you.