Whilst reading the FT recently, a quotation from Niels Bohr raised a wry smile. “Prediction is very difficult, especially about the future”. The quote was used in an article regarding the outlook for IPO’s in 2023, however some of the fundamental points raised can be applied to SME and Mid-market valuations ahead of a business sale.
Predicting the future is indeed difficult, however it is not impossible. By narrowing down the variables, an approximation can be determined, and providing there are no big surprises, the result can be estimated with some confidence. The devil's detail is my qualification here. No. Big. Surprises.
Unfortunately we live in a world of big surprises stemming from Brexit, lockdowns, and a conveyer belt of Conservative chancellors. This has hammered confidence in what the future may look like. For the past 6 years we have struggled with prediction as we just have no idea what is coming around the corner.
So in this climate, when is the right time to sell a business? Predictably, one answer is when the market is full of willing buyers. This is easier to predict than macro-economic indicators would suggest. A buyer wants to make a return. They want to minimise risk, and they want a competitive advantage.
So how do you tell if the market is full of willing buyers? With lead times on deals typically running between 9 and 12 months, waiting for hard market data can mean that the optimum time has been missed. The most accurate way is to speak to M&A advisors who are in the market, day to day, and have their finger on the pulse.
A buyer will base their valuation on perceived risk and certainty of earnings, which usually means multiples of earnings (or revenue) on past or current performance. They can hang their hat on this and providing market fundamentals don’t change, some certainty can be given to future profitability expectations.
Obviously from a sellers point of view they want value for their marketing, pipeline and potential for the future. To go to market with a robust set of forecasts and revenue models is therefore key to demonstrate why and how a valuation expectation is being put forward.
Building a robust model, shows, in black and white, the earnings potential and expectations. Crucially, the assumptions underpinning the model should be clear, simple and conservative. This leads the buyer to focus on earnings potential, rather than historic performance. Their valuation then stems from the future, rather than the past.
James Wilkins
James is a Chartered Accountant and Director at Symmetry Corporate Finance.
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