Is the business valuation your actual selling price?
- Mac
- 25 minutes ago
- 6 min read
For many SME owners who thought of selling their business in Singapore, it’s common to see them approaching a third-party business valuation firm. Yet often time, they get a shock when they received the offers from the buyers. There tend to be significant valuation gap in the offers, compared to the figure in the business valuation report. While most people are not aware, a business valuation report can only serve as a guide. Given the myriad factors that can contribute to the actual selling price that was being transacted.
In today’s article, we aim to illustrate the common factors that will influence the actual selling price of SME business. The common factors include:
1. Quality of Business
2. Profiles of Buyer
3. Deal Structure
4. Business Hygiene
5. Market and Economy
A - Quality of Business
What does quality of business means? For most SME owners, they probably have a big question mark on this question itself. Given that their primary focus is on running the day-to-day operation itself.
Whereas for a business acquirer or investor, they are likely to vet through 100 – 500 teasers (marketing collateral for the sale of business) before acquiring one. This allows them to evaluate the available businesses for sale and pick the best one, aka comparison. Pretty much like house hunting. The difference is that the deal quantum is bigger and it’s more likely to be ROI driven. The question now is what influence the quality of business then?
1. Financial Health
This has a major influence for most investors’ decision. A business with 25% net profit margin is more attractive than a business with 5% net profit margin, if all things remain the same. Likewise, a business with 30% Y-O-Y growth rate is going to be more attractive than a business with stagnant/ negative growth. Level of debt matters too. If a business comes with a high level of liability, this might raise concern to the investors as it is an indicator of poor cashflow from the business or something else.
2. Quality of Earning
Does the business have any customer concentration risk? If company A has a customer that contributes 90% of their entire revenue, whereas company B has 10 customers that each contribute 10% of the total revenue. Company B is deemed as a safer business, all things being equal.
Likewise, if company A revenue comprises of monthly maintenance or retainer contracts, whereas company B revenue comes from a major project. Then company A is a safer bet. A good example is Netflix. Will the management of Netflix lose sleep if I decide to turn off my Netflix subscription tomorrow?
Whereas if a construction firm needs to suddenly pause work on a major project that contribute 40% of their revenue, I doubt the SME owner would have a good night sleep.
3. Business Moat
Does the business have a moat? In case you are wondering what a moat is. You can tell if a business has a moat by their ability to increase the price of their product or services. For example, if a business can increase their selling price by 10% - 15% without losing many customers, then that business has a strong moat. A good example is Google Workspace, if today they raise their price by 10% globally, I don’t think they are going to lose many customers.
There are other factors that will impact quality of business, including brand equity, customer retention, level of inventory, age of business, etc.
B - Profiles of Buyer
There are 2 main categories of buyers - Financial acquirers and Strategic acquirers.
Example of financial buyers are Search funds, PE Funds, Acquisition Entrepreneurs, Family Offices. Example of strategic acquirers are roll-ups, industry peers doing bolt-on acquisition, vertical or horizontal acquisitions.
Different profiles of buyer have their own unique characteristics in terms of valuation metrics, internal scorecard, M&A process, selection criteria and risk.
Most strategic acquirers tend to focus on acquiring businesses with minimum enterprise value of at least SGD $20 mil, with proper book-keeping and no major red flags.
C - Deal Structure
Very often, SME owners would have peers who would humble brag about their achievement when they successfully sold their business. They will share the enterprise value without going into the exact details and context of it. It’s important to know that most deals entail the following deal structures:
100% Full cash payout upon closing
This type of deal structure is uncommon, and I wouldn’t encourage it unless it’s a small and simple deal. Closing the deal successfully is just the first step of a successful exit. There needs to be a proper transition and handover too. Things can go wrong during the handover period too.
Fixed multi year payout
It typically involved a designated payout amount in the first few years, with 2 to 4 years being the norm. e.g. 50% of the total consideration - 1st year, 30% - 2nd year, 20% - 3rd year.
Earn-out deal
The total payout amount is tied to certain performance indicator over preceding period. This form of deal structure is typically used to bridge the valuation gap between what the business owners want and what the buyer is prepared to pay. E.g. 50% of the total consideration is fixed, the balance payout is tied to the revenue / profit achieved in the 2nd and 3rd year. There is risk associated to earnout deal as well.
The type of deal structure can have a significant impact on the total enterprise value.
D - Business Hygiene
Business hygiene refers to the current state of the business internal operation itself. You can think of it like a medical check-up, where your blood pressure, cholesterol, weight, height, eyesight, etc. Common aspect of a business hygiene includes the following:
1. Book-keeping
Are the accounts properly done up? If the accounts are not, buyers will question the accuracy of the numbers and subsequently reduced their valuation offer for the business.
2. Inventory stock take
Is the inventory level up to date, and able to stand up to the rigour of a third-party inventory audit? How about the obsolesce level? What has been done for obsolete products? Is it properly write off?
3. Proper SOP
Are there documented standard operating procedures (SOP) guiding the different departments/ staff in their workflow?
4. System & Process
Are customer contacts and transactions being uploaded into a customer relationship management software (CRM)? Is the accounting properly recorded in the accounting software? Is there a clear organizational chart and flow chart? Is there a clear scope of who does what?
5. Key man Risk
Are all the major customers account owned by the owner? Is the owner the main salesperson? Is there a senior manager who can hold the fort, should the owner decide to go on a 1 or 2 months’ vacation. The less dependent the business is onto the owner, the better it is. Most SME owners neglected this aspect and build the business around themselves. Indirectly turning themselves into a permanent employee for the company.
6. Team capability
What is the overall calibre and capability of the personnel? Are there long serving staff who can aid in the organizational knowledge transfer? Are there capable 2nd layer management in place? Most SME owners has a tendency to hire Grade B and Grade C employees, just to fill the gap rather than for out-performance purpose.
7. Customer quality and retention rate
A simple way to assess a business sustainability is to assess the type of customers a company has and their retention rate. If a business has customer turnover issue (meaning low customer retention rate and low customer lifetime value -CLV), this is going to be a headache for the future business owner.
The above are some common ways to assess a business hygiene level. There are other aspects to lookout for as well. When it comes to business hygiene level, the higher it is, the better outcome due diligence process will reveal.
E - Market And Economy
Buyers’ motivation in pursuing M&A can easily be shaken by the overall market sentiment, especially for first-time business acquirer. Moreover, for business acquirers dependent on financing facilities, any market fluctuation that impact interest rate can potentially increase the cost of capital. Thereby affecting the total consideration / enterprise value.
Certain sectors and business models can have a heavier weightage on investors preference. All this will directly impact the number of active investors and total offers made for a particular mandate too. In Singapore, healthcare, education, accounting, technology businesses are particularly popular with investors. Thereby driving the valuation multiples.
The above factors will create a dynamic impact on every deal. Hence every deal is unique by itself, and a business valuation report can only serve as a guide.
Fey Day is a M&A firm in Singapore that provides business brokerage service for SMEs in Singapore and Malaysia. We are predominantly a sell-side representative that focus on M&A and fundraising.
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