In the feverish mergers and acquisition climate of the last few years, company small talk has inevitably steered to, “How much did old Joe get for his business?” It’s not surprising really. The media regularly reports yet another design consultancy sale or merger (another word for sale).
The reason given for this is usually “industry consolidation”. While this may be so, it is also true that the major networks have to keep on acquiring in order to achieve financial analysts’ and shareholders’ expectations of growth. And these expectations are for higher levels of absolute growth than organic growth alone can satisfy. Valuing companies in the creative industries is part science, part art.
There are two commonly used methods to establish the value of a consultancy – a multiple of your earnings (by far the most common in the UK), and a percentage of gross profit (the net income received from clients which is then available to pay for the staff, premises and other overheads.) But the key is to be able to take a dispassionate view of your business across a range of factors, the balance of which will determine a sensible price tag.
We commonly see multiples on post-tax profits in the range of six to 12 times. Within this range, where your consultancy falls will depend on the balance of “pluses and minuses” in the business; and the general state of the market.
Scarcity value – if your consultancy has particular qualities that are especially attractive for certain buyers, such as specific clients, intellectual property rights, strong management, or a very distinctive or niche positioning, up to 50 per cent could be added to the figure that would be quoted for a comparable private business without any of these characteristics.
Fundamental goodwill – a clear momentum built up over years of trading could mean that, in a sense, the company assumes a life of its own, almost regardless of who actually does the work. Such evidence contributes to confidence about the sustainable profitability of the business and therefore enhances its value.
Timing – there are two issues here. First is the position of your company on the profit curve. If you are still (demonstrably) coming up the growth curves you are in a much stronger position than if you are a mature business close to, or at, its peak. Buyers want the company they buy to carry on growing, so the moral is – don’t leave it too late when considering when to sell. The second point is that with the pace of change in the marketplace, it may be that your investment in certain skills, such as technology, could be ahead of the game. A buyer may see exceptional possibilities in being able to take a short cut to satisfy its own need to change.
Synergy – an overused word, but there are times when the value of your consultancy will be greater than the sum of its parts. One point to bear in mind here is that there are, as far as you are concerned, two types of buyer. Those which think your business is a “must have” and those which think it is a “nice to have”. No prizes for guessing which will give you a higher valuation.
Scale – there is no doubt that as sustainable profits expand, certainly beyond £500 000 pre-tax, the multiple can increase. Such businesses are inevitably perceived as less risky and more attractive to a buyer, and certainly more economic for acquirers to be spending management time and shareholders’ money on.
Operating profits are less than 5 per cent of turnover – the business is marginal; profits can be eliminated by relatively minor difficulties.
A patchy record of sustainable trading profits – the key word is sustainable. Evidence from the past will give confidence for the future.
Management – a lack of succession management, or well-trained and motivated key people and so on, will be of significance, as will over-reliance on one or two key individuals.
Reliance on one or two clients, or a narrow field of services – this will normally be viewed as unattractive and can result in a heavy discount.
Weak positioning or strategy – if the company has no distinctive features as a standalone business, its value is reduced.
Adverse working capital position – if the company is carrying debt which cannot be eliminated at the time of sale, then this will depress the valuation. If the buyer has to carry the cost of your loan, overdraft or whatever it is, he will simply knock the indebtedness off the initial payment made to you.
Looking at the second method, the percentage of gross profit basis, in our experience, very few businesses are actually sold for more than their gross income/ gross profit. A value in the range of 60-100 per cent of gross profit is normal, based on an assessment of the balance of the above factors.
There need to be very strong and clearly identifiable pluses to justify exceeding this figure. The most likely of these is probably scarcity, in the sense that your business may be the only one – or one of two or three – that fits the buyer’s specification. Or it could be operational synergies, particularly where merging requires only a core of staff to move along with the clients. There are, of course, many other factors to be considered in this sort of deal which make it far less simple than it might sound.
Many owners, however, have a “gut feel” price which will override such rational assessments. It is important to say that there is nothing wrong with this. If you had always really wanted £2m for the company, when an assessment values it below this, the conclusion would have to be not to sell now, but to find ways of enhancing the premium value in the business.
So assess your business as objectively as you can, then consider your gut feeling.
Results Business Consulting is a specialist adviser to the advertising, design, PR, interactive and marketing services industries