Hello again, another week has passed and it has been an interesting one. Thanks to everyone who has responded to our recent emails – your support really means a lot to us. The overwhelming majority of responses were in our favour which should confirm that we are on the right track. Now we are moving on and continue to talk about positive things.

The eternal dilemma as brokers is finding a fair market value (FMV) of a subject business that all parties can agree on. Now that is probably an impossibility, but finding a FMV that all parties can live with is more achievable.

Drilling down to identify the intangibles (previously referred to as Goodwill) seems to be the most successful way for us to give comfort to the purchaser and his/her advisors and financiers, while at the same time showing the owner how his/her business is and can be affected by market forces so as to be able to manage the value expectations to a reasonable level.

It can be a tightrope, but when acceptance has been achieved, the sale process is more efficient and pleasant for all the parties involved. As an example, are two manufacturing businesses that have an annual turnover of $2m and an EBIT of $500K located in the same city with identical plant and stock values worth the same? If you looked at the normal methods of business valuation (Earnings, Comparative or Assets) you would have to assume that they would be similar at least.

But this really couldn’t be further from the truth because there are so many other factors at play that will affect the risk profile of each of these businesses and consequently their value. The most important factor to consider is the sustainability of the income or profits. So really, most factors that you would try to identify would be measured on whether they affect the sustainability of future profits negatively or positively and to what degree.

This probably sounds simple, I know, but it takes some work, it takes some experience and it means you have to take a position that you feel you can defend.

If we take our two manufacturing businesses, let’s ask ourselves what factors could affect the future maintainable profits of these businesses:

1. Cashflow/Quality of debtor book. Who are the customers? What are terms of trade? Do they collect monies owed as agreed?
2. Income risk. Is income contracted? Are margins secure?
3. Working Capital requirements. Any stock requirements? Terms of trade from suppliers?
4. Growth prospects. Is the business growing, stable or in decline? Is there anything unique about the business? Do they have new products/services?
5. Competition. Where does this business sit it relation to competitors? Is the business at risk to competitors?
6. Transition. Will the current owner stay on to ensure transition? Are supply agreements assignable? Will staff accept new owners?
7. Barriers to entry. Is there a barrier to entry?
8. Location or lease. Is the location suitable for a current business and for growth? If so is there a good lease available to a new owner?
9. Capital Expenditure requirements. Is the Plant and Equipment current? Are there Capex requirements in the business?
10. Concentration risk. Is there a good spread of clients? Does one client make up more than 20% of sales? Is the business at risk to any of its clients?

There will be more to look at obviously on specific businesses, but these are a good start on what you would need to take into account when setting a capitalisation rate or multiple for your business.

To give you an example of this, we were recently referred a business that was primarily a service provider but also designed and built solutions for SOEs and large businesses primarily in the North Island. The factors that we took into consideration in setting the value were as follows:

• One of few businesses we had seen where the result for 2009 year was up on 2008 year.
• Vendor will stay on indefinitely as an employee to ensure successful transition.
• At least 30% of income is long-term contracted work.
• Significant barriers to entry with both technical nature of the business and the market acceptance.
• Multiple income streams, no concentration risk.
• Quality debtor book with government departments, SOE’s and large private sector companies. Over 90% of debtors inside 30 days and a significant portion inside 14 days.
• Great growth prospects actually on the table for a new owner to benefit from.
• No capex requirements.

After taking these factors into consideration we advised the owner that we thought a FMV for that business would be set at 3.1 times (30% cap rate) 2009 EBITDA ($420k) or 3.3 times (32.3% cap rate) 3 year average EBITDA ($453k) which gave us a value of $1.4m. This multiple/cap rate we believe is on the high end of what is achievable in the current market, but after taking into account the factors above we felt it was fair. When we marketed this opportunity we advised all parties that these were the factors we took into account in setting that multiple or cap rate. The business was on the market for 10 days, we had 4 offers and the business is currently in Due Diligence.

So if you are a business owner and you are wondering what the FMV of your business would be, what factors might influence the value of your business and how you could enhance them and/or how you might go about selling your business, you should look at the factors listed above and see how your business measures up, and then call an experienced broker and get them to spell out the process and agree on a FMV for the sale of your business. Conversely, if you are looking to buy a business, the factors above will help you analyse whether the opportunity you are looking at is worth the price it is being offered at. You should always ask the broker to advise you what factors and assumptions he/she took into account when setting the FMV and asking price on the opportunity they are marketing.

That’s it for this week. Have a great week.