insights
What are vendor loan notes in business valuations?
If one is using the Asset Approach to value a business, possibly as corroboration of other methods, it’s important to adjust the assets.
There are several reasons why getting a business valuation is a useful tool for strategic planning or the owner’s eventual exit when preparing to sell your business.
Most assume that a valuation would only take place at a point of selling a business, and that this value is synonymous with the price paid on said sale.
However, price and value can be two very different numbers, and there are several reasons why, as a business owner, valuing your business is a useful tool to aid either your own, or your business’s future.
A business valuation can be considered a ‘sober assessment’ of the current value of the business. It focusses on what the business is doing in its current state, using both historic data and forecasts to determine the current fair value.
Price can be defined as “the value agreed between a willing buyer and a willing seller”. The price of the business can vary significantly to the value depending on the buyer and the buying process.
As part of any buying process, it’s key to bring in several viable purchasers to get multiple motivated buyers – this is likely to increase the price achieved as the competitive tension can drive the price up. Potential buyers are also likely to see synergies or have a strategic motivation for a potential purchase, which is also likely to incur a bid premium on any offer for a business (knowns as a “Bid Premium”).
When a business is underperforming or where a seller is uninformed, there may be an expectation gap between the value a buyer and seller may place on the business. Where a potential buyer is negotiating with an uninformed seller, buyers will chance their luck for a bargain price. In this scenario the price would be lower than the value of the business. On the other side an uninformed seller may overestimate the value of the business and look to achieve an unrealistic price.
By undertaking a valuation before embarking on a full sale process a business owner can perform a ‘hygiene test’ on their own expectations and see if the business is worth what they think it is. If the reality is that the business is worth less than they originally thought, then the owner can assess if they still want to go through with a sale or configure a plan to get the business to the aspiration exit value (discussed further below) without incurring any unnecessary sales process costs.
A business valuation means offers can be discounted quickly if they come in significantly lower than the valuation. It’s worth mentioning that just because a potential purchaser has purchased a company before, does not mean they have paid/will offer fair value!
We have recently performed a valuation for an company where the clients had received an offer which they were minded to consider. This offer was received before the clients had even considered an exit and therefore represented an Off-Market Approach. As the buyer approached before other parties had chance to come to the table and before a valuation had been completed the offer was below expectations. Once we performed a valuation it was determined that the offer was c25% of what we believed the fair value of the business to be. This allowed the client to reconsider their options and discount this offer.
For help and support selling your business, get in contact with our specialists.
A common rationale for business valuation is the issuance of employee incentives such as EMI or Growth Share schemes. One way to incentivise individuals who are key to the business’s success is to offer them shares or share options which participate in the capital value of the company above a predetermined threshold value (usually close to the company’s current value). These schemes incentivise employees to maximise the growth of the business as they have a stake in the value above the determined threshold level.
To set an appropriate threshold value, the current value of the business needs to be determined and then the threshold value is set in relation to this. Usually, the threshold value is calculated with a small uplift on the current value to give the recipients of the scheme an achievable target to give their share/options value in the short-term.
HMRC may enquire about the threshold set on issuance to determine if the appropriate tax has been paid. At the time of writing (2024), a full valuation report can form part of sufficient evidence, if prepared correctly, to justify the threshold value set. Additional tax advice should be sought if a share incentive scheme is being undertaken to confirm this and if there is any additional ‘hope value’ to be considered at point of issuance.
Where these schemes may recur annually, or if staff are wanting to track the performance of their share, a recurring valuation may be useful to a business owner to adjust threshold values where appropriate or to show their staff the impact of their hard work in the year.
Whilst an exit may not be imminent, a current valuation can provide an insight into what an exit may look like in 5/10 years’ time. In some instances, understanding your business’s current value may change your opinion on when you would like to exit. Some business owners struggle to see the value they have created over the years of work and the market may suggest that it’s a good time to sell, or the opposite where it’s not quite ready to be taken to market. Understanding this enables an informed decision to be made to maximise the return from your business.
A valuation provides the opportunity to assess where the business could save money and what needs to be improved to shape the company into being as attractive as possible to a potential buyer.
If following a valuation, weaknesses have been identified, PEM Corporate Finance are happy to partner with business owners to help devise a strategic plan to help improve the business – whether that be to aid growth, or to identify opportunities to ‘trim the fat’, making the business more marketable for a future exit. Get in contact to discuss your requirements in further detail.
If the business is formed of multiple entities providing different services, a valuation may also highlight which entities are contributing most to overall value, or worth investing in for future growth.
A business owner might decide they want to take a portion of capital off the table, whether that be to deploy elsewhere in another business venture, de-risk, pay off the mortgage, or school fees. Getting a valuation gives clarity on what proportion of the business could be sold to facilitate cash demands elsewhere or what the cash benefit to de-risking would be.
Additionally, a valuation can also be useful if looking for additional funding, particularly if Private Equity (PE) investment is a consideration. Understanding the value of the business before starting these discussions means a more informed conversation can be held surrounding PE involvement and the figures to be discussed.
If you are preparing your business for sale, planning your exit strategy, or are looking to conduct a strategic review, get in contact with our valuation experts to get a professional, accurate value for your business.