Business Valuation: What's Your Firm Worth
Entrepreneurship Expert at BizLaunch.ca
If it was just about making money today, you would likely be an employee. But as a professional in your own firm, it’s also about the future. You are creating value and building equity to be cashed in when you retire or leave for a new opportunity. Take the time to understand how professional firms are valuated, so that you can continually increase and leverage the value of your firm.
Plan for the future
While most professionals think they need a business valuation only when they’re ready to sell their firm, knowing the worth of your business is also helpful for financing, succession and tax planning. “Professionals should actively consider the value of their business, “says Ian Wintrip of the valuation firm Wintrip, Wolkoff, Shin Inc. “They may not be aware that the value of their business is stagnant. It may even be in decline. But if they actively consider what drives its value, they can do things that help the value go up.”
As with any sale, understanding what motivates prospective buyers is important for building and communicating value. There are basically two categories of prospective buyers for professional firms. They are:
• Strategic purchasers - another professional services firm looking to expand their firm or add synergistic services through acquisition. • Financial purchasers - this may be a private equity firm looking for a financial return in 3-5 years. Their exit strategy likely involves selling to a strategic purchaser and includes a specific return on their investment.
What purchasers look for
Professional firms are based on human capital. They are about the lawyers, engineers or chiropractors who deliver the firm’s services and the relationships they have with their customers. Even veterinarians and dentists who have a substantial amount of equipment are really about the partners and staff in the firm. Buyers look for firms that are led by partners with good reputations and that effectively utilize quality people.
Once a firm has been identified for potential purchase, the prospective buyer will determine what they want to pay, based on cash flow and risk. They will consider:
• Financial statements - revenue and profit margins are key for purchasers who will seek opportunities for growth and to increase margins through synergy with their firm.
• Hard assets - software, equipment, value of work in progress.
• The number of partners and employees that are in the firm.
• Profitable utilization of people in terms of partners, managers and staff.
• The firm’s culture -
o Strategic purchasers want a culture that will mesh well with their own firm.
o Financial purchasers look for a culture that is financially strong, sustainable and adaptable to growth.
• Expertise - this is particularly important for strategic purchasers who generally want to expand their capacity in their current expertise or add a complimentary expertise.
• The nature of the clients and services -
o Repeat clients - if a firm’s clients return for the same services on a regular basis, like a semi-annual check up at the dentist, the firm has more value.
o Project clients - if clients purchase one service then don’t return year to year, like a homeowner buying a design from an architect, the firm has less value.
• Goodwill - this is a tricky area for professional services firms. In essence, the more the business relies on one or a few key individuals in the firm for its success, the lower the goodwill. The value of a sole practitioner could be very low because clients are committed to the professional not to the firm. Generally, the more partners a firm has and the broader the client base, the greater the value of the company’s goodwill.
A multiplier is the number by which cash flow is multiplied to determine the value of a firm. Everyone wants to know what that magic number is. But there is no ‘rule of thumb’ when it comes to a multiplier for the sale of professional firms. Every company must be evaluated individually. The multiplier is affected by two things:
• Level of cash flow.
• Level of risk in terms of the issues identified above.
If a company is in demand and there is competition on a purchase, the multiplier may be higher.
It’s important to remember that strategic purchasers are making a ‘build or buy’ decision. If developing new capacity internally is less expensive in terms of time and money than the cost of buying that same growth, a prospective buyer may build instead of buy and become a competitor.
If you’re buying/When you’re buying
Start your search with your professional association. Firms wanting to sell may have informed the organization or may be advertising in their journal. If you aren’t successful there, your lawyer or accountant may be able to help.
While you may not be looking to buy now, you may want to buy down the road. With this in mind, stay connected in your profession. “The best target is a known target,” advises Wintrip “Meet and speak with your competitors on a regular basis. Be congenial. Understand what you can about them as they may be the company you want to buy in the future. This knowledge will also help if they come shopping for you.”
If you’re selling/When you’re selling
The first thing to do is call a business valuator to determine the value of your firm. They can also help you find people who may want to buy. Surround yourself with experienced people. “Clean house a bit. Find out what you can do to increase the value of firm in eyes of a purchaser,” says Ian. “Like staging a house for sale you need to present your business in the best light possible. One of the biggest things you can do is have a solid business plan in place.”
Growing the value of your firm should be an ongoing strategy. Learn as much as you can about how your specific firm is valuated so you’re ready to tap its full potential when opportunities arise.
Small Business Expert Roger Pierce is co-founder of www.BizLaunch.ca.