During the third quarter of 2009 the Private Company Price Index (PCPI), which gives an indication of the average multiple of after tax profits at which private firms are sold for, rose again – much to the delight of anyone looking to sell a business. This is the second quarter in a row that we have seen rising multiples being paid. Please see our previous blog on business valuations rising posted in October.

Although merger and acquisition activity declined in the third quarter, for the seventh consecutive period, the multiples of profits at which business for sale are being sold for increased by 5 per cent. With the 5 per cent rise, people selling businesses were achieving an average of 11.7 times their historic after-tax profit. Of course, it should be noted that these figures relate to announced deals which have an average deal size of £15m. Smaller businesses multiples are lower overall to reflect the increased risk but if you wish to have a guide on the possible value of your business then please feel free to fill out our form for a no obligation business valuation

In addition to improvements in the PCPI, the Private Equity Price Index (PEPI), which tracks the multiples of profits that businesses sold to private equity achieve, also reported good news, rising 4 per cent to 12.3 times.

The continuing slow M&A market can be partly blamed on a more restrictive lending policies, particularly within the leveraged buyout market. This is reported to have offset the benefits an increase in corporate bank debt available to people wanting to buy a business for sale.

The increase in confidence among the corporate finance community has helped to boost the amount of money companies are being sold for. In addition, the number of exit reviews, proposals and pitches is increasing in response to a change in sentiment among business vendors. Many are realising that income and capital gains tax increases will catch up with them next year and that selling a business takes several months to complete – leading to an increase in the number of business being put on the market.

Business Sale Report has seen a 20 per cent increase in listings in the past quarter! To contact the sellers of these businesses then please subscribe.

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If you have a successful and profitable magazine title to sell, and a genuine reason for selling it, you are likely to have very few problems doing so. Buyers want to see forecastable future cash flows and authentic reasons for selling. In these circumstances, you can achieve a high price for your publication.

Of course in this day and age the internet is a vital channel for your magazine readers. Even if you have not yet fulfilled your plans for an online version of your title, a detailed plan on how you will create this will usually encourage buyers to be interested.

Timing is vital when selling a magazine title. Proving you can make money from the title is crucial as investors are no longer keen to risk precious cash on a risky forecast alone. Make sure you can show potential buyers that there is money to be made from their purchase.

Understanding your buyers can help you to establish the best way to market your title – talk to industry buyers about synergies and speak to financial buyers about profits – basic really!

Having the best possible advisors on board to help you with the sale will really help you to achieve the best price when selling a magazine title. They will be able to give you an objective view of your business, they will know who the likely buyers are, and will be able to spend time on marketing your magazine for sale. This will allow you to concentrate on running the business instead of getting wrapped up in emotive negotiations. Also don’t forget to get good tax advice not least because selling business assets (i.e. a title) is treated differently from selling business shares. For more information on these issues you can subscribe to the report.

For help on determining the value of a magazine title then please fill out the no obligation business valuation form.

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Prices paid for businesses show signs of improvement as debt/funding availabilty increases. Higher business valuations are likely to follow.

Average multiples paid for larger private businesses in the second quarter of 2009 were up 10% over the first quarter, according to the Private Company Price Index.

The Private Company Price Index (PCPI), produced by accountancy firm BDO Stoy Hayward, tracks the relationship between the current four-month rolling average FTSE Non-Financials price/earnings ratio (p/e) and the p/es currently being paid on the sale of private companies to trade and private equity buyers. It is calculated as the arithmetic mean of the p/es for deals where sufficient information has been disclosed.

On average, larger private companies are currently being sold for 11.1 times their historic after-tax profits, while the metric for private equity purchasers, PEPI, shows that larger private companies are being sold to private equity buyers for 11.8 times their historic after-tax profits.

BDO Stoy Hayward notes that as private companies are generally owner-managed, reported or disclosed profits tend to be suppressed by various expenses that may be non-recurring under a new owner.

While this will have been factored into the price the purchaser paid, it may not be reflected in the profits declared publicly. Consequently, the p/e paid, as calculated from the publicly available information, may be overstated.

Over the last six years, deals included in the PCPI have had a mean size of approximately £21 million and a median size of around £6 million, though the PCPI is an average measure and guide rather than an absolute measure of value.

The PCPI for the second quarter of 2009 shows improvement over the pricing dynamics for the first three months of the year, although aggregate M&A activity declined for the sixth consecutive quarter to a total of 476, from 515 transactions between January and March.

Although the decline in the volume of deals has reduced, the types of transaction taking place differ from those of 2007 and early 2008 in that a greater proportion have undisclosed values.

Debt-for-equity swaps are occurring more frequently as business stakeholders realign their interests in the equity.

Two transactions during 2009’s second quarter topped £250 million with private equity involvement, bringing the total of leverage transactions in the last 12 months to five.

The first was an approach made by STT Communications Limited, a subsidiary of Singapore Technologies Telemedia, to Irish telecoms group Eircom through Eircom Holdings, the company’s Australia-based parent. It was seeking to replace previous investor Babcock and Brown, currently in administration.

The second transaction was Charterhouse Capital’s £553 million acquisition of energy research unit Wood Mackenzie, forming part of British buy-out fund Candover’s stabilisation programme to boost cash reserves.

With an uncertain economic climate as a backdrop, the ability to support historic levels of finance raised will become more challenging, prompting companies to realise proceeds from non-core assets to cut their debt burden.

The previous route, where a leveraged organisation repaid debts by relying on business sales to a trade acquirer or refinancing through a secondary buyout, is not currently available in most instances.

Christopher Clark, M&A partner at BDO Stoy Hayward, says this is part of the reason for the lowest pricing metrics being paid during the first three months of the year.

The PCPI shows that the values attributed to the companies being bought or sold from April to June increased against the previous quarter.

Average multiples paid by trade buyers increased 10% from the January-March period to 11.1 times the companies’ historic after-tax profits.

The PEPI was up 13% to 11.8 times and the average public company p/e for the Financial Times Non-Financials Index was up 9% at 9.3 times.

Pricing dynamics during the three months to June have shown improvement, Clark concludes, indicating that “as debt availability improves, acquirers can improve the pricing they are willing to pay”.

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More than a third of management buyouts in the UK since the start of the year occurred at companies in administration, as private-equity firms target failed businesses. Private equity firms with cash and those less reliant on debt have been particularly successful in this regard.

Research on the first quarter of 2009 by the Centre for Management Buyout Research (CMBOR) shows companies in administration surpassed family-owned and closely held businesses as a source of management buyouts for the first time since CMBOR began gathering data in 2000.

Since the start of the year, of 61 management buyouts in which managers of a company bought the company they work for — usually with the help of private-equity funds — 38% involved companies in receivership. This compares with 11% for the whole of last year and 5% in 2007

These deals, which tended to be smaller in size, constituted 14% of all management-buyout deal value, which is £1.95 billion ($2.84 billion) so far this year. Although about half of management buyouts are private-equity backed, CMBOR said, these transactions make up the vast majority of total deal value.

Conversely, family-owned and closely held companies were the source of 28% of deals in the first quarter, compared with 42% last year and 41% in 2007. Secondary buyouts fell to just 7% from 19% last year.

Of the £1.95 billion in total value of the 61 UK management-buyout deals, two-thirds was from one deal: U.K. buyout house Permira Advisers LLP, News Corp. and NDS Group PLC taking television-technology company NDS private. It has been the slowest quarter by number of deals since records began in 1990.

In the final three months of 2008 there were 92 deals worth a total of £1.3 billion, and in the first quarter of last year there were 152 deals worth a total of £7.5 billion.

If the market continues at this pace it will be the slowest year by management buyout volume since 1981, when there were 152 deals worth a total value of £267 million. It would also be the slowest year by value of deals since 1995 when there were 598 deals worth a total of £5.6 billion.

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The third quarter of 2008 saw a marked reduction in the number of deals that completed in the UK. However, for those that did, prices held steady. The Private Company Price Index (PCPI) p/e ratio for sales of companies to trade acquirers was 11.5 times, up marginally on the previous quarter’s 11.3 times. Similarly, the Private Equity Price Index (PEPI) p/e ratio was 11.2 times which remained relatively unchanged from the previous quarter’s 11.1 times.

To recap, the PCPI, compiled by BDO Stoy Hayward, tracks the sale prices of large businesses as a multiple of their after tax earnings. However, as owner managed profits tend to be understated to avoid taxation then the multiples will tend to be overstated as the information is gleaned from publicly available information.

By comparison, the FT Non-Financials Index (FTNF) fell 11 per cent this quarter from 12.4 times to 11.0 times, most noticeably hit by the turmoil in the markets caused by the collapse of the banking sector in the second half of September.

Full report available in our subscriber section.

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I got pitched a question last week from a principal of a software business.

He asked what were the most common valuation approaches used for valuing a small software company in a slow-growing market segment with revenues around £3m, growing 20% per annum. The company has ‘good’ technology though not ‘killer’.

We can come up with any number of valuation methods, but the only one that ultimately holds true for a private company is the market-determined valuation. This is the price a buyer is willing to pay and that a seller will willingly accept for the business for sale.

Potential buyers may have completely different reasons for purchasing the business. It may be that the buyer is specifically interested in the target’s technology, for which a grander application is planned. Or its established distribution channels. Or its outstanding human resources. The market-led valuation approach implies that the methodology for valuing a business should be determined by the purpose behind the proposed purchase.

Although ultimately the most accurate, this approach is not overly useful in enabling business sellers to quantify their expectations. So I’ll take a quick look at some approaches used for justification of the setting of asking prices by vendors and offer prices by purchasers.

1] Asset Valuation
An accounting-based approach that subtracts business liabilities from business assets to arrive at the business value.

Simple at first glance you might think; but is difficult to know what assets and liabilities to include and to place a standardised value on them. If an asset is not included on the balance sheet – let’s say a unique proprietary technology process, then it will not be accounted for in the valuation. Though you can be assured a business will always be worth at least the value of its assets less its liabilities.

More problematic is that this approach does not take into account the profitability of a business, so its application is limited for the valuing of most solvent trading companies.

2] Discounted Cash Flow
The Discounted Cash Flow (DCF) approach is a technical valuation technique used with companies, which are moderate to high cash generators or are soon expected to be cash-generative. It looks at today’s value (at a given rate of return) of the accumulated profits of the business over a number of years added to the value of the business in today’s terms if it were sold at the end of this period.

How might we apply this to the software company owner, if we knew his company generated cash and we decided to use this approach?

There are several ways to apply DCF. Here is an example where we shall project realistic cash returns for the next 5 years and discount them at a rate acceptable to an investor at 20%. So, let’s say the projected earnings of this software company added up over the next 5 years came to £2m. At this discount rate, that £2m in 5 years is equivalent to £800k today.

We assess what the residual value of the company might be in 5 years time (apply an industry multiple to the average earnings in years 3,4 and 5 with a weighting to year 5). To make the calculation simple, let’s say the residual value is £10m. Apply a discount of say 20% (we’ll guess this is the acceptable investor rate of return) – and you have a discounted residual value in today’s terms of £4m. Add back in the discounted cash flow: £4m + £800k = £4.8m.

Some investment banks prefer to use the more scientific basis for calculating the discount rate: the weighted average of the costs of debt and equity capital. Here’s an example. The business has post-tax cost of debt of 7% and an estimated cost of equity of 25%. It plans to raise capital 30% by way of debt and 70% by way of equity and computes the cost of capital at 19.6% as follows:

So what are the problems with the DCF approach?
It is not easy to apply! To forecast the future cash flow of the business, you are going to have to prepare a full financial model. This is going to need some serious analysis of the business, the macro-economic environment, the legal and regulatory framework and the competitive landscape.

To complete the equation, we still have to make a judgement on the residual or terminal value of the business, for which there are several calculation methodologies. The terminal value is sometimes determined using multiples from comparable firms.

Or we can assess a terminal value by sticking to the DCF fundamentals. This is often called the “perpetuity method” and assumes a growth rate ‘g’ of a perpetual series of cash flows at the end of the period (5 years in the software company example).

Tp = (CFp x (1+g))/r-g

Where:
Tp = the terminal value at the end of the period p
CFp = the projected cash flow in period p
r = the discount rate
g = the estimated future growth rate of the future cash flows beyond p

The other problem the valuer is faced with is that if the current or expected market conditions are turbulent, forecasting cash flows maybe pure guesswork.

Other complexities also come into play. To an extent the acquired company’s future cash flows depends on the acquisition method and the purchase price. How is that? The acquired business’s future cash flows are directly affected by the taxes it will pay. The taxes the company will pay depend on its taxable income. And the taxable income will partly depend on its taxable deductions for depreciation and the amortization of intangible assets. These deductions depend on the acquired company’s tax basis for its assets, which in turn depend directly on the purchase price paid for the company.

3] Comparables Valuation
Here an attempt is made to extrapolate or interpolate the value of the business by using information collected on similar business sales in similar markets. This approach is the closest simulation of a true market-led valuation.

The market has paid £x for ABC; the market has also paid £y for DEF, therefore because of the similarities between ABC, DEF and YOURCO, we can estimate that there is a strong probability that YOURCO will fetch £z.

Certain industries have their own ‘rules of thumb’ that are commonly used as comparison standards for setting prices for businesses for sale. Usually these are profit multipliers for an industry sector within a country, but sometimes the rule is based on another variable peculiar to the industry i.e. barrelage in the pub sector, customer numbers for a mobile phone air-time provider. But just because a rule of thumb has been extensively used in the past does not mean that it is necessarily the right approach to take – particularly when the rule of thumb is based on a criteria other than net profitability.

The profit multiplier or price earnings ratio is a common business valuation guide used, especially in the UK, when a business is both established and profitable. It saves us from having to deal with the forecasting issue when cash flows are difficult to predict. But always use this ‘cheap and cheerful’ method with caution; the value you end up with may be substantially different to the figure produced by a business valuation expert with experience in your industry.

To see how this variance may occur, let’s look at two hypothetical companies that operate in capital-intensive tech sector. Let’s assume this sector uses a rule of thumb that estimates the value of a company as 6 times EBITDA. We will assume that these two businesses are identical in every way with the exception that one business has plant and equipment that is newer and more efficient, requiring much less re-investment in capital assets to sustain the business.

Company A and Company B both have EBITDA of £1m. Ostensibly, according to the industry rule of thumb, they are both worth the same at £6m. But Company A requires £200k of capital investment each year to sustain the business, whereas Company B needs only £50k. Would you not prefer to purchase the business with the higher cash flows? On close inspection it transpired that company B had substantially higher admin costs that could be trimmed right back upon acquisition giving the purchaser a much higher ROI.

Comparables valuation is a clearly useful approach when the right information is available on other companies that we know are similar in most respects. Unfortunately, this information is not always able to be collected. It is more often used in industries with simple business models and where there are many players. With larger and more complex business, there are fewer comparable companies.

However, in the absence of comparables, the profit multiplier technique is still widely used as a valuation yardstick. I often see private companies go up for sale for between 2.5 to 5x earnings (generally the higher the annual revenue, the higher the multiple). Why is it 2 1/2 to 5 times earnings? Well, to buyers, such a multiple represents getting their investment back in 2 and a half to 5 years from profits. That’s equivalent to a projected annual return on investment between 20% and 40%. And this is the type of return rate that encourages buyers to take the leap of faith to buy an existing business.

Buyers will often use one or more of these approaches to see whether the result of the calculation falls close enough to the asking price to give it some validation.

These are the most prevalent valuation approaches used in the market. If you are looking for more, you need only go to half a dozen business brokers or valuers and ask them to assess the value of the company and to explain to you how they get to the figure.

You will be amazed at the variances. As a special service to our Blog readers, we are offering a free business valuation from one of our in-house experts. Just complete our short valuation request form.

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