[This is a guest post from Colin Howe, a tax specialist at Hillier Hopkins. Colin co-presented a seminar with me on how to build value into a business. In this post he shares some of the insights that he presented on the day to the attendees.]
A big thank you to Chris and the Franklins team for inviting me to write a post for them on this subject.
One of the issues that is constantly relevant to any business owner – even if day to day concerns sometimes get in the way – is the value of that business.
Notwithstanding the variety of methods that exist, the truth is that valuation remains “an art rather than a science”.
So, as it’s important, what are some of the things that can be done to optimise the value of your business? It’s worth thinking through a number of key issues:
1. Think about your objective
The optimal value for your business will depend upon what aim you’re trying to achieve. If you want to sell your business in the short-medium term, then maximising the value is likely to be important to you. Of course, in the old phrase, a business is only worth what the purchaser will pay, so many of the ideas I mention below will be highly relevant. However, if any valuation is being prompted by a dispute between shareholders, then you may not wish the value placed to be the highest possible one.
If you’re trying to clarify a tax obligation, then it may be more beneficial to – completely legitimately and appropriately – value on a different basis.
We help clients in all these scenarios, but in each case understanding the aim is key.
2. Sustainable profit
In some cases valuation may be undertaken based on the net assets of the business. The business sector you operate in may also have an impact. But most of the time, any purchaser will be interested in future profitability. So it is very likely that the valuation will be strongly influenced by the price earnings ratio. So, for some companies, the starting point may be (say) 6 times annual profit – but the sustainability of profit will have a profound effect.
Purchasers will look at the history of profitability and dividend payments, and the regularity and future predictability of the pattern they see. Really significant value can be generated by a business and its owners, not only when considering a sale, but throughout the life of the business if some very achievable and appropriate ways to boost profitability are considered.
As well as growing a strong top line, and putting in place effective cost controls (of course) there are other influences on this. It’s useful to consider some less obvious items as highlighted below:
Put yourself in the shoes of a prospective purchaser. High uncertainty is normally bad. One useful way of improving the sustainability of profits and to reduce the uncertainty of future net revenue is to “de-risk” them.
Examples of ways in which you can de-risk your business include:
- Protecting Intellectual Property. Any buyer will want to be comfortable that what they are buying is protected. Currently, this also has an additional benefit in many cases as registering a patent allows for tax relief under the Government’s “Patent Box” scheme.
- Key staff. What would be the impact on your business if key staff left? Share incentive schemes and other methods of reducing this risk may be appropriate. These can be geared to specific targets being reached.
- Customers. Being over-reliant on a small number of customers that represent very high proportions of your revenue constitutes a high risk, not only when considering sale but in the ongoing health of your business. There is also high risk if all your customers are in one sector. So it may be worth extending and diversifying your customer portfolio.
4. Other areas to consider
Other areas which can be highly relevant to optimising profitability and/or the value of your business include:
- Reviewing relationships with suppliers to ensure the best terms (but also reducing any risk of over-reliance on one supplier) See more in Chris' blog post here.
- Good management information systems may help you in various ways – for example they can enable you to far better understand the underlying profitability of specific customers, products or your business as a whole
- Appropriately identifying and taking advantage of relevant tax reliefs that may be applicable to your business
- Understanding the impact of your premises on your value. For some businesses and purchasers premises may be highly valuable; in other situations they may have no value as the purchaser has no need of them. It is worth thinking this issue through and determining how premises should be reflected on the balance sheet.