Centurion Entrepreneurs

From the desk of John Brandow

Buying, selling a business
Proper planning needed to set the right price
Chris Koen, Regional General Manager, Business Partners Ltd



Entrepreneurs are attached to their businesses – and that is understandable. So much effort, blood, sweat and tears are poured into starting and growing the business. That makes it very difficult to consider selling the business without attachment and emotion.

However, it is important to look at the deal (buying or selling) objectively.

A number of issues should be considered and thoroughly researched before the business is put up for sale:

* Are the financial statements up to date and of a high standard?
* Potential buyers – who would consider buying the business, what background, experience and available capital should the buyer have?
* Finding a reputable agent who can be trusted to sell the business
* What would be the role of the business's accountant in the process?
* Appointing an attorney to ensure all legal processes are complied with
* Determining the selling price – what is the value of the business, and choosing a reputable valuator

Determining a fair market value is often the most difficult issue to resolve and a professional opinion should be obtained. There are a number of methods generally used to value different types of businesses. Some of these are:

An earnings multiple - based on the premise that the value of an asset is only worth the income/cashflow streams it can produce

P/E (Price/Earnings Ratio) - quite simply, this implies the level of earnings the buyer can earn from the investment (Price to acquire the business), for example, should the NPAT (nett profit after tax) of the business be R1,0 million and a fair P/E ratio is 5, then the value of the business as a going concern would amount to R5,0 million (= R1,0 mil x 5)

EBITDA - Earnings before interest, tax, depreciation and amortization

This method is mostly used where fixed property forms a substantial part of the operating business such as a guesthouse.

For example, should the EBITDA amount to R1,0 million and a fair multiple is 7, then the value of the business as a going concern would amount to R7,0 million.

Cap rate - a capitalization rate is normally used to determine the selling price of a fixed property earning a rental income, assuming the value of the assets is determined by the cashflows it generates. For example, should the earnings before interest and tax amount to R1,0 million and a Cap rate of 11% is deemed fair, then the market value of the property would be R9 090 909 (R1.0Mil/11%)

NAV or net asset value - this method is sometimes used when a buyer would take over all the current liabilities in the business as well. (Total value of assets minus total value of liabilities)

DCF or discounted cashflow - this values the future income stream of the business. It should normally only be used when there is a fair degree of certainty of future cash being generated (for example, contracts for future delivery to reputable companies/institutions)

In summary, the buyer wants to determine if he or she will be able to generate a fair return on investment should they buy the business at a given price.

A fair return is sometimes difficult to determine, but it usually relates to the return one should be able to get on a risk free investment (like at a bank), plus a risk premium. If the purchase price of the business is for example R5,0 million, one should be able to generate a risk free return of say 10%. Can this business generate a NPBT (nett profit before tax) of R500k plus a risk premium? The risk premium is the difficult factor to determine and would depend on the type of business or industry. As a rule of thumb a risk premium in these times could probably be as high as 35%. Therefore 10% x 35% = 13.5%; and the business should then reasonably be expected to generate a NPBT of at least R675k.

Any serious buyer will do a thorough due diligence and it normally relates mostly to the financial position of the business. The seller should make sure that he or she has a good set of financial statements for at least the last three years available. These should be signed of by the accountant of the business, as well as the directors or members of the business, and should preferably not be older than three months. Any anomalies in the financial statements must be summarised and available to the buyer.