With the Irish economy continuing to improve, there is an increasing level of activity in business sales and transfers, and consequently requests to perform valuations of businesses and/or of shares in companies are increasing.
The number of business startups is also on the rise, often undertaken with a future sale of the business in mind, therefore valuations are also being performed as a benchmarking exercise, to monitor the overall increase in the value of a business as it grows.
However, there can be a wide divergence between the expectations of a business owner/manager as to what their business (or their shares in a company undertaking a business) is worth, and the view that might be taken by a professional valuer in assessing the market value of the business or shares, particularly in the case of small businesses.
This reflects the fact that business owners are usually fully committed to their enterprise, and this can make taking a dispassionate view of the value of the business very difficult.
Opinions on what a business is worth are often reflective of ‘rules of thumb’ (e.g. worth X times turnover) and small and medium sized business are in fact often not saleable at all, as they may in fact be very dependent on the continuing personal involvement of the owner and/or key personnel.
In managing expectations, therefore, the following factors need to be taken into account:
A professional valuation is prepared at a particular point in time, and usually is in fact an estimate of what a purchaser would pay for the business at the time the valuation is prepared, rather than on what price a seller would like to achieve.
Valuations are based on an estimate of future income (i.e. profit and/or capital appreciation). This will in the first instance be based on recent actual financial performance and not on unsupported estimates of future growth, or anticipated savings that may accrue to the future owner (this ‘value’ normally resides with the buyer, not the seller!) At the same time, an enterprise premium may be applicable if potential future growth in sales and profits can be demonstrated.
A multiple is normally applied to the calculated future income and it is important to realise that the multiple for a smaller business is generally lower than for a larger business, reflecting the difficulties smaller businesses routinely face, such as sourcing of finance. A ’rule of thumb’ approach, disregarding the size of the business being valued cannot therefore be applied across the board,.
The multiple can also reflect contractual arrangements, including those impacting sales and continuity of supply (the duration of sales contracts with key customers and suppliers), product and services life cycles etc, and the continuing involvement of key personnel. These factors will be unique in different businesses and their impact will therefore need to be assessed for each valuation.
The value of assets is not normally relevant, except that the value of ‘surplus’ assets (such as cash in excess of that required to run the business) should be added to the value based on future income.
Other issues such as the age of plant, and any need for re-investment, may also need to be taken into account.
A further complication that may arise is the valuation of a minority shareholding in a company. The value of such a shareholding will normally be discounted, reflecting the fact that minority shareholders often cannot impact key decisions taken by the company, including the appointment of directors, and whether a dividend is paid. The relevant discount will vary with the size of the minority shareholding, and could be over 50% for shareholdings of less than 25%.
Shareholders Agreements are sometimes in place and often include clauses as to the valuation of shares. It must be borne in mind that such clauses may be historical and therefore not always relevant to a current ‘market valuation’.
There are also Revenue rules which need to be considered. This is very important in the event of a company buying back shares, as payments made in excess of what Revenue deem to be the capital value of any such shares could be ‘grossed up’ and subjected to higher rates of income tax rather than to capital gains tax.
There are therefore a lot of factors to consider in valuing a business.
It is very worthwhile to do your ‘homework’, and to ensure that all required information is to hand (e.g. audited financial statements, up to date management accounts, up to date Business Plans, key contracts and bank facility letters). This will help focus on what is relevant and facilitate an independent professional valuation to be prepared.
A valuation is rarely a simple task, therefore, hopefully, being forewarned will help you to be forearmed!
We can advise as to the valuation itself and on the tax consequences of any related transactions.
For assistance please contact:
Dermot Carey (Head of Audit)
Declan McEvoy (Head of Tax)
David Leydon (Head of Food and Agri)