Business owners, like homeowners, occasionally like to see what their prized asset is worth. You’ve put the long hours in, built a business, attracted customers, surely they’ll be someone out there prepared to pay a decent price for all your hard work. Unfortunately, the picture isn’t quite as rosy as it seems.
According to the latest analysis of some 20,000 business owners, the average offer being made by acquirers is just 3.7 times the pre-tax profit. Companies with less than a million pounds in sales garner significantly lower multiples, while larger businesses may get closer to five times the pre-tax profit. But regardless of size, private company multiples are still significantly less than those reserved for public company stocks.
There is no standard price-earnings (P/E) ratio figure that can be used to value every business. But if you’re bricks and mortar business, for instance, you can expect a much lower ratio than, say IT or technology. The same applies if most of your eggs are in one basket, and you’re over-reliant on one product, or a small team of senior people. Again, your ratio will be downgraded.
Given the not very exciting offer multiples on the table, you may be tempted to hold on to your business and decide to “milk it” for decades to come. After all, if you hang onto your business for four or five more years, you could withdraw the same amount in dividends as you’d get from a sale and still own 100% of the business. Sounds like win-win.
This logic – let’s call it the “Just Milk It Strategy” – seems sound on the surface, but there are some issues to consider.
You shoulder the risk.
The biggest downside of holding on to your business, rather than selling it, is that you retain all of the risk. Most entrepreneurs have a tendency towards optimism, but you need only remember the uncertainty around Brexit or the fact that annual growth in 2019 was the weakest since 2010, to know that economic cycles don’t always work in your favour. While business may feel good today, the next five years could be bumpy, and you’re the one still in the driving seat.
Disk Drive Space.
If you think of your brain like a computer’s disk drive, owning a business is like constantly running anti-virus software. Yes, in theory, you can do other things like play tennis, go skiing or enjoy a bicycle ride through Tuscany and still own your business. But as long as you’re the owner, your business will always occupy a large chunk of your brain’s capacity. This means family fun, holidays and weekends are always tainted with the background hum of your brain’s operating system churning through data. And that’s before we’ve even mentioned your phone, or your in-box, or your diary.
Let’s say your business generates £500,000 in earnings before interest, taxes, depreciation and amortization (EBITDA). You have two options – you could sell your company for four times EBITDA or keep it. You may argue it’s better to keep your business, pull your profit out in the form of dividends, and capture the same cash in four years as you would by selling it. Unfortunately, this theory breaks down in any capital-intensive businesses where there is usually a big difference between EBITDA and cash in the bank. If you have to buy machines, finance your customers, or stock inventory, then a lot of your cash will be locked up in feeding your business, and the amount of cash you can pull out of your business each year is a fraction of your EBITDA. The truth is, you may not be as cash-rich as you think.
Depending on your tax situation, the proceeds of any business sale may be more favourably treated by HMRC than the income you’d garner by paying yourself handsomely month in, month out. You may actually earn more from the advantageous tax treatment of a business sale than you could by paying yourself regularly on the “Just Milk It Strategy.”
The Multiplier Effect.
We’re not advocating you should sell your business. You built it, you decide what you do with it. But it’s worth bearing in mind that, should you decided to sell, while you may attract an offer three or four times your pretax profit, you could actually generate much greater value in your company. Businesses we work with who have a Value Builder Score of over 80 get offers that are, on average, 6.1 times their pretax profit. Some owners do even better, stretching multiples into double digits.
Curious to know more? You can start by finding your Value Builder Score. It’s a thirteen-minute questionnaire that will give you a score based on the current value of your business. But more importantly, we’ll show you the steps you can take to improve this score and increase the value of your business. It could be your most profitable ever use of thirteen minutes.