Advisory Board
If you own a business that has been impacted by a significant event and still want to sell, there are ways to proceed sooner rather than later.
In accounting language, the normal benchmark for business value is a required rate of return [capitalisation rate] applied to Future Maintainable Earnings [FME]. In everyday terms, that is: adjusted net profit before tax multiplied by a ‘multiple’ that accounts for the risk of earning that profit in the future.
From the purchaser’s perspective, they are thinking: “What am I prepared to pay now to earn that amount of FME each year into the future?”
what happens if my profit has been affected?
When your historic earnings have fluctuated, or you have been impacted by an unforeseen event, and projections are unclear, it is more difficult to determine the underlying level of FME.
Greater than usual fluctuations can increase the perceived risk; a purchaser will require a higher rate of return, which means you will be looking at a lower earnings multiplier.
the danger of averaging in an abnormal year
The overall impact may be a reduction in assessed value, even if the true underlying earnings have returned to ‘normal’ levels.
For instance, consider a business that earned $1 million [before tax] for two years, then had no profit in the following year, and is now showing year-to-date results trending back towards historic levels. If you average all years, including the depressed years’ results, you may have a distorted estimate of the future earnings.
can you exclude a “one-off” year?
The challenge is in assessing how business performance will rebound. Where a return to ‘normal’ earnings is evident in the future, it may be justifiable to exclude unusually high or low historic results from the assessment.
However, if the unusual result occurred in the most recent full year, it does not automatically follow that the next year will return to the historic ‘norm’. Why? Because markets change, complete recoveries are not guaranteed, and new baselines are not always easy to plot.
what should I do?
In this situation, it is important to provide detailed and substantiated forecasts of the current full year’s trading results. Such an assessment incorporates current year-to-date performance, plus projected results for the remainder of the period.
Substantiation of forecast assumptions may include data such as:
- leads generated,
- proposals issued,
- sales projected using historic conversion rates, or
- actual orders in hand.
What you are looking for is something concrete to base your forecast assumptions on.
The Covid -19 period provided examples where some businesses were severely impacted, while others achieved substantial growth. In both cases, historic profit trends were impacted, making assessments more challenging. It was only in the years following, as the impact of the Covid period diminished, that trading patterns settled, and the ‘new normal’ level of performance was established.
what are some options as a seller?
Business owners have some options, including the more obvious ones:
- Wait for the market and profits to stabilise and establish a new, consistent track record. The downside is that this strategy may take several years, and the result is not assured.
- Prepare a full year’s trading report for a more current period, such as the 12 months to date, then prepare a detailed forecast for the next period, as described above, with clear evidence-based assumptions.
- Sell at a discount. Not everyone wants or needs to maximise the sale price outcome, and other considerations may take priority.
what else can be done to maximise my business exit?
How you structure your exit transaction becomes critical and is why professional advice is essential. With some creativity and expertise, it is possible to structure an agreement that can deliver the true value of the business and crystallise a sale sooner.
For example, if the owner is confident that the worst is behind the business, then it may be in everyone’s best interest to share the risk and responsibility to manage the business through to smoother waters. In this case the deal may include a structured price model that includes some of the proceeds paid on settlement, according to recent baseline performance, and provision for further payments as profit milestones are reached, commonly called an ‘Earnout’.
Naturally, it is always preferable to have a clean transaction without strings attached. However, provided the up-front amount is sufficient to allow the seller to proceed, and further payments are considered a bonus, then the ultimate result could work well for a retiring business owner.
where to from here?
Understanding your business value from the outset is essential and keep in mind that the sale transaction is only one element of an exit process. To maximise your exit outcome, it is essential to plan ahead, know your numbers and have your business ready to sell.
we’re here to help
So, whether you want to sell your business soon, need assistance building a valuable asset for the future, or just want to talk through your plans with an experienced advisor, contact Brad Dean on 0417 886 352 or at b.dean@businessdepot.com.au.
want more from us?
Sign up to our mailing list below!
businessDEPOT Broking Pty Ltd is a member firm of Divest Merge Acquire, a market leader delivering exceptional results in the sale and acquisition of medium and large Australian businesses.
This article is reworked from the original produced by Divest Merge Acquire following the GFC.
