valuing a business-goodwill

bmwguy

What calculation would you boardsies use to value a business? The net assets part is fine assets less liabilities but what would you use for goodwill. I'm leaning towards about 5 years profit before tax, the businesses I will be looking at will be in the manufacturing sector. All will be going concerns and the products demand will stay strong. They will become part of a wider group, and economies of scale beyond what they can achieve at the moment will occur.

jimmii

5 years seems a good rule of thumb these days though you do see some mad earnings to value ratios though.

Voltex

Has the goodwill value been capitalised onto the balance sheet? If not the value appropriated needs to be verifiable.

barneystinson

Voltex wrote: »

Has the goodwill value been capitalised onto the balance sheet? If not the value appropriated needs to be verifiable.

Huh? The OP is asking about valuing a business, has said they're happy about valuing the net assets (I.e. the bal sheet) and is asking about valuing goodwill, which clearly isn't on the balance sheet... I think you just wanted to use some big words...!

Voltex

barneystinson wrote: »

Huh? The OP is asking about valuing a business, has said they're happy about valuing the net assets (I.e. the bal sheet) and is asking about valuing goodwill, which clearly isn't on the balance sheet... I think you just wanted to use some big words...!

The OP is looking to buy an existing business..or at least that's the way I read it. What big words threw you there? Capitalised, verifiable, balance sheet?

I did also imply that in the absence of a value..one given should still be verifiable (IAS 38).

barneystinson

Voltex wrote: »

The OP is looking to buy an existing business..or at least that's the way I read it. What big words threw you there? Capitalised, verifiable, balance sheet?

I did also imply that in the absence of a value..one given should still be verifiable (IAS 38).

Nothing you said threw me. OP is asking how he should value the goodwill, I read it that he's the prospective purchaser. IAS38 doesn't come into it from that perspective, this isn't an accounting question.

Voltex

barneystinson wrote: »

Nothing you said threw me. OP is asking how he should value the goodwill, I read it that he's the prospective purchaser. IAS38 doesn't come into it from that perspective, this isn't an accounting question.

...and hence the reason people ask questions on forums such as this. Multiple perspectives.
Unfortunately we all suffer the notion of bounded rationality. Asking fairly open ended questions such as the OP's facilitates replies that allow for boundary spanning.

barneystinson

Voltex wrote: »

...and hence the reason people ask questions on forums such as this. Multiple perspectives.
Unfortunately we all suffer the notion of bounded rationality. Asking fairly open ended questions such as the OP's facilitates replies that allow for boundary spanning.

Yep. Words. You didnt, and still haven't, answer the question the OP asked.

Voltex

barneystinson wrote: »

Yep. Words. You didnt, and still haven't, answer the question the OP asked.

How can the Op's question really be answered? Warren Buffet once said “Price is what you pay. Value is what you get.” Without fundamental and technical analysis of the numbers how can someone on here comment on a valuation?

I suggested a direction...what's your contribution?

bmwguy

I was asking for a method of valuation, not an actual valuation. The idea here is that we have a family business and the founder has stated that in 5-8 years time he will be selling it and retiring. In the meantime we will be trying to buy up a few competitors and suppliers (or any viable business really) adding value to them and selling as a group. I dont think I'll be able to retire on it myself, far too young, but I might get a nice cut. Really any businesses bought would need to payback initial investment in this 5 to 8 year timeframe, so current profit times 5 or 6 would be maximum. Hopefully we can add profitability and recoup it quicker, then sell it all. Thanks for the discussion

Peterdalkey

Cant see the logic in this. If all you end up with is investment recovery over the period, where is the financial upside to reward the investment? If you buy at say 5X earnings, I would expect to recover initial investment in less than 3 years by cutting costs and expanding the trading volumes /margins.

Voltex

bmwguy wrote: »

I was asking for a method of valuation, not an actual valuation. The idea here is that we have a family business and the founder has stated that in 5-8 years time he will be selling it and retiring. In the meantime we will be trying to buy up a few competitors and suppliers (or any viable business really) adding value to them and selling as a group. I dont think I'll be able to retire on it myself, far too young, but I might get a nice cut. Really any businesses bought would need to payback initial investment in this 5 to 8 year timeframe, so current profit times 5 or 6 would be maximum. Hopefully we can add profitability and recoup it quicker, then sell it all. Thanks for the discussion

It depends then on the strategy then. The example Iv looked at recently was the Musgraves acquisition of Superquinn.

In 2010 The Musgrave group had booked goodwill in at €120 million. They were turning over €4.3 billion and an EBIT of €75 million. They then bought SQ in 2011 for €228million with fair value on the tangibles being €126 million. The goodwill arising was valued at €102million. Hardly consistent..but the strategy behind the acquisition was clear. Musgraves works off low net margins and requires volume sales and market share to deliver growth.

SBWife

Goodwill is just a consequence of valuation.

I'd value the business as a whole based on a multiple of profits or cash flow, can't give you what multiple I'd use without further information as regards the size of the business, the industry, comparative transaction valuations etc. Once you have the value you are prepared to pay for the business as a whole subtract net assets and you get goodwill.

bmwguy

Peterdalkey wrote: »

Cant see the logic in this. If all you end up with is investment recovery over the period, where is the financial upside to reward the investment? If you buy at say 5X earnings, I would expect to recover initial investment in less than 3 years by cutting costs and expanding the trading volumes /margins.

The logic is by adding value to the business we buy. Almost exactly as you have outlined. The first is a supplier we are looking at, very small but profitable to the tune of 50k on turnover of 300k. I have a figure in my head of paying about 250k for this business but improving their sales/profits through access to our customer base and other factors such as shared bookkeeping/accounts fees. I would hope to make them profitable by 80-100k per year and then when time comes to sell, if the same logic applies it would be worth 400-500k.
Is my thought process sound? I've little experience with this but its fairly exciting all the same.

SBWife

BTW the Net Assets may not be as straightforward as you indicate. As part of a sale transaction the assets would normally be subject to a revaluation, so the values that go onto the acquiring company's balance sheet won't necessarily be at the same valuation that they are currently at in the stand alone business.

bmwguy

SBWife wrote: »

BTW the Net Assets may not be as straightforward as you indicate. As part of a sale transaction the assets would normally be subject to a revaluation, so the values that go onto the acquiring company's balance sheet won't necessarily be at the same valuation that they are currently at in the stand alone business.

The assets are quite small, easy to value. No premises involved in the sale. Stock, plus debtors less creditors. No bank loans. Its the future earnings/payback that will need a bit of calculation. Do we pay on current profit levels or do we factor in the added value we believe that we can bring to the table? I'm thinking we shouldnt pay for this and pay on current situation

SBWife

Valuation is an art not a science. You want to pay enough to get the business but not so much that it won't deliver the a return to you the purchaser. Establish a range based on existing profits and business on the bottom side and the synergies and additional business you can bring on the top side. Aim to be in the bottom portion of the range but paying enough so as to not encourage resentment and negative goodwill among any employees and customers that you expect to bring along with the business. The amount you pay will also be impacted by whether or not there are other bidders for the business and by how motivated the current owners are to sell.

Voltex

SBWife wrote: »

Valuation is an art not a science. You want to pay enough to get the business but not so much that it won't deliver the a return to you the purchaser. Establish a range based on existing profits and business on the bottom side and the synergies and additional business you can bring on the top side. Aim to be in the bottom portion of the range but paying enough so as to not encourage resentment and negative goodwill among any employees and customers that you expect to bring along with the business. The amount you pay will also be impacted by whether or not there are other bidders for the business and by how motivated the current owners are to sell.

So from the Op's perspective he should focus on the incremental cash flows generated from the purchase for his own valuation of goodwill?

The first is a supplier we are looking at, very small but profitable to the tune of 50k on turnover of 300k. I have a figure in my head of paying about 250k for this business but improving their sales/profits through access to our customer base and other factors such as shared bookkeeping/accounts fees

I'm just curious about this bit. If the business you intend to buy is a current supplier to you..how will access to your customers improve the business?

I'm also just wondering would the cash flows in this business cover the cost of financing the purchase without harming future valuations?

Value Hunter

bmwguy wrote: »

The assets are quite small, easy to value. No premises involved in the sale. Stock, plus debtors less creditors. No bank loans. Its the future earnings/payback that will need a bit of calculation. Do we pay on current profit levels or do we factor in the added value we believe that we can bring to the table? I'm thinking we shouldnt pay for this and pay on current situation

A couple of things that cross my mind,

1. Count the full value of the businesses debt, but not the full value of the money their debtors owe them. Use a discount of between 5 - 10% (to cover if debtors default).

i.e if the amount receivable is €50,000, value it at between €45,000 and €47,500.

2. I wouldn't include a valuation on goodwill for such a small company.

If I was too value this business, I would use a simple 'back of a cigarette box' calculation


Net Assets (minus goodwill and discounting account receivables) = x

Net Liabilities = y

Annual Profit = z

Valuation = (X - Y) + 2(Z)*

I would use 3 times annual profit if I believed the probability of growing profit was almost a certainty.


Obviously this formula would only suit certain businesses, it would drastically undervalue a business with low assets but very good profitability, so use your own judgement with regards the type of business you are acquiring.

bmwguy

Voltex wrote: »

So from the Op's perspective he should focus on the incremental cash flows generated from the purchase for his own valuation of goodwill?

I'm just curious about this bit. If the business you intend to buy is a current supplier to you..how will access to your customers improve the business?

I'm also just wondering would the cash flows in this business cover the cost of financing the purchase without harming future valuations?

Our current main company turns over 40 times what the target company does. Their main product is a complementary product to our main product and if owned by us, would be heavily marketed to end users (in favour of alternatives) which doesnt happen at the moment. Sorry for vagueness but just dont want anyone being identified!

SBWife

Voltex wrote: »

So from the Op's perspective he should focus on the incremental cash flows generated from the purchase for his own valuation of goodwill?

He shouldn't focus on the goodwill valuation at all but on valuing the company as a whole. The incremental cash flows should help provide a maximum valuation but naturally the ideal is to pay significantly less than that maximum.

Voltex

bmwguy wrote: »

Our current main company turns over 40 times what the target company does. Their main product is a complementary product to our main product and if owned by us, would be heavily marketed to end users (in favour of alternatives) which doesnt happen at the moment. Sorry for vagueness but just dont want anyone being identified!

Thanks for the reply OP. Just wondering how you would finance this acquisition?
Sounds like you have a pretty good plan and vision for how the business will benefit. Just playing devils advocate here...but vertical integration isn't something id see a lot of these days...more the strategic alliance model. Have you objectively looked at both options?

Peterdalkey

Voltex wrote: »

Thanks for the reply OP. Just wondering how you would finance this acquisition?
Sounds like you have a pretty good plan and vision for how the business will benefit. Just playing devils advocate here...but vertical integration isn't something id see a lot of these days...more the strategic alliance model. Have you objectively looked at both options?

Owner managed/sme businesses and acquisitions are about control not cooperation arrangements, theory and real practice diverge on this one!

Voltex

Peterdalkey wrote: »

Owner managed/sme businesses and acquisitions are about control not cooperation arrangements, theory and real practice diverge on this one!

Dr Gurgiev's review of 2013 Irish M & A data supplied by Experian.

The number of small deals (under €12mln fell by 11.1% on 2012’s figures; down from 54 to 48 transactions. The aggregate value of small transactions also fell - by 26.3%, from €243mln to €179mln

http://trueeconomics.blogspot.ie/2014/01/1412014-irish-m-activity-in-2013.html

Would you say Peter a decision or action that increases the perception of control supersedes a decision that may maximise shareholder value in the mind of a sme owner?

DubTony

I tried to read this thread but couldn't find my dictionary/thesaurus.

:pac:

Peterdalkey

DubTony wrote: »

I tried to read this thread but couldn't find my dictionary/thesaurus.

:pac:

tis always a danger with book-learning!!

barneystinson

Voltex in particular floccinaucinihilipilificates the use of plain English

DubTony

Peterdalkey wrote: »

tis always a danger with book-learning!!

Yeah. I knew I should have gone on and done that MBA. Or even the degree. Or the diploma. Or the leaving cert.

bmwguy

Voltex wrote: »

Thanks for the reply OP. Just wondering how you would finance this acquisition?
Sounds like you have a pretty good plan and vision for how the business will benefit. Just playing devils advocate here...but vertical integration isn't something id see a lot of these days...more the strategic alliance model. Have you objectively looked at both options?

Sorry havent checked in here for a while. Yes we have a fair idea on how to make the business benefit. It will be financed from our reserves or a bank loan, probably reserves,its not a huge figure for us with the relative size differences between the acquiring and target companies

Voltex

DubTony wrote: »

Yeah. I knew I should have gone on and done that MBA. Or even the degree. Or the diploma. Or the leaving cert.

The bigger problem is that the more you "learn" the more aware you become of the volume of what you don't know.

Voltex in particular floccinaucinihilipilificates the use of plain English

I prefer an efficient and effective use of the English language.

smcgiff

Good advice here from SBwife,

Your plan is sound OP, trying to create synergies and make better use of the target's opportunities.

As for how much to pay... It's not unusual for the seller to seek more than what the purchaser should pay (taking everything into account) especially if the seller wasn't considering sale before approach.

Times turnover or profit is a common approach, but you'd want to know a lot more about the target company to be more specific.