Owners ‘give away’ the business in rush to retirement

Is your business worth less than a year’s earnings? You need to ensure you get fair value, ANDREW KENT reports.

By Andrew Kent

The latest BizExchange Index has revealed an alarming trend of an increasing number of small business owners selling their businesses for less than a year’s earnings. In effect they are virtually giving the business away.

While it is not the first time that a business has been sold for less than it earns in a year, this had previously been regarded as an anomaly – possibly the result of a forced sale through personal circumstances such as the death or injury of a key person.

The BizExchange team noticed that there was a scattering of businesses offered for sale at less than a year’s profit in the December quarter, but regarded them as outside the normal course of events.

For the latest BizExchange Index, which was an assessment of 5000 print and online advertisements for private businesses for sale during the March quarter, this scattering has become a significant number of small businesses in wholesale trade, retail trade, hospitality and transport – three of the traditional strongholds of small business.

While the retirement of baby boomers has been expected to put pressure on business valuation, BizExchange is surprised by the speed of the decline at the lower end, particularly as the peak of baby boomer retirement is not expected until 2009.

There is also anecdotal evidence to suggest that some business owners, particularly in the construction industry, are not even bothering to sell their businesses. And other research suggests that the majority of business owners are relying on the sale of their business to fund their retirement, so it would appear that many are not going to have the retirement they hoped for.

But it was not all bad news for business owners this quarter. Two of the micro-market segments (retail and hospitality) that went into decline at the lower end also had significant gains at the upper end, with the common price being relatively steady in the range of two or three times earnings. Construction businesses presented for sale also managed to maintain their value.

These results tend to indicate that people will pay for quality and highlight the importance of preparing a business for sale properly.

There was also good news at the larger end of town, with a return to the traditional rule of thumb that the larger the business the better the price-earnings multiple. This has been largely underpinned by the activity of private equity firms, which continue to pursue value in privately owned businesses.

Advisers have also adjusted their expectations, moving from a largely negative position last quarter to having a strong expectation that business values will hold steady for the next 12 months. This is not unreasonable, because the relatively low average earnings multiples at which businesses are selling represents a return on investment of between 25 to 50% – which should ensure that valuations for sound businesses don’t fall much further.

The contrast between these predictions and the bottom end of the micro business market are stark, but understandable.

Larger businesses are generally less reliant on the owner for their ongoing success, and so the departure of the owner in the sale process has less of an impact on the business valuation. Even in the micro market, the high variance between the bottom and top of the market is often representative of the quality of the business entity and its ability to operate independently of the owner.

Business owners contemplating selling in the next few years would do well to work on ensuring their business can run without them – it could make it 10 times more valuable. Another thing to contemplate is making the business bigger, perhaps buying competitors. A larger business able to operate independently of the owner is much more saleable.

Extract from BizExchange Index – March Quarter 2007

Full copy available for free from www.bizexchange.com.au