Valuation vs readiness: why a number is not the first step

What a valuation actually multiplies

For most trading businesses, the common approach is profit multiplied by a profit multiple. Price Bailey, an accountancy firm that sells valuation and sale advice, describes it in those terms, and notes that EBITDA is used because it excludes non-cash expenses and exceptional, non-recurring items.

Both halves of that sum are judgements. The multiple is drawn from comparable businesses that have sold, and moves with sector, size, the quality of the revenue and the state of the market. The profit is not the figure in your filed accounts but an adjusted one, after add-backs and deductions a buyer will each test; EBITDA add-backs explains how that adjustment works.

Other methods exist, such as valuing the net assets of a property or investment company, or discounting forecast cash flows for a larger business. Profit times a multiple is simply the one most owner-managed trading businesses meet first.

So a valuation is less a fact about a business than a view on two inputs, and the earnings input is the one an owner can do most about before a sale.

Why the earnings figure comes first

A buyer does not accept the earnings figure on trust. In due diligence their accountant rebuilds it from the ledgers, and anything they cannot evidence tends to come out. If a price was agreed on the earlier figure, the change usually lands late, after months of work and often after the owner has told family or staff.

Typical reasons the figure moves have nothing to do with how good the business is:

• Add-backs without documents, or “one-off” costs that recur.
• Filed accounts and management accounts that do not agree, with no reconciliation between them.
• Money moving between the owner and the company outside salary and dividends.
• Owner pay below what a replacement manager would cost, which a buyer deducts.

Each of these is fixable, but rarely in the middle of a sale. That is the practical case for looking at them before anyone puts a number on the business.

How an early number plays out in a sale

A number heard early tends to become the reference point for everything after it. If an owner has a figure in mind before marketing starts, each offer is measured against it, and a gap feels like a loss even when the offer reflects what the evidence supports.

Offers for private businesses are usually made subject to due diligence. Heads of terms set out the proposed price and structure and are usually not legally binding, apart from points such as exclusivity and confidentiality; the buyer then tests the figures behind them before the sale and purchase agreement is signed. Where the earnings figure holds, the price usually holds too. Where it does not, the buyer may come back with a lower figure, a larger share deferred or tied to future performance, or wider warranties and indemnities.

None of this means a number is unhelpful. It means a number is most useful once the inputs to it have been tested, because that is the version a buyer will end up working from.

What readiness means in practice

Readiness is not a score. It is a list of what a buyer will question, and whether you have the answer and the paper to show it. A valuation tool and a buyer ask quite different questions:

The right-hand column is what due diligence works through, and the exit readiness checklist sets it out as preparation.

Two businesses with the same profit (an illustration)

Take two invented businesses, each reporting the same profit after add-backs. A quick valuation tool, given the same inputs, would return the same result for both.

The first has an add-back schedule with an invoice behind every line, accounts that reconcile, no customer above a tenth of sales and a manager who ran it for a month while the owner was away. The second has add-backs explained from memory, a large gap between its two sets of accounts, nearly half its sales from one customer, and an owner who has never taken more than a week off.

A buyer would almost certainly see these differently: the second invites more questions, more conditions and more room for the earnings figure to move. The number at the start was identical; what decided the conversation was readiness. The illustration says nothing about what either would be offered.

Where to get a number, when you want one

Wanting to know roughly what a business might be worth is entirely reasonable, and there are good routes to it:

• Your accountant, who knows your figures and can say which adjustments are likely to stand.
• A corporate finance adviser or business broker, many of whom offer an initial view as part of discussing a sale.
• Online tools, such as the Marktlink Multiple from the M&A adviser Marktlink, which asks for revenue, EBITDA, sector, headcount and contact details, and says its outcome is indicative only.

Each is more useful once the earnings figure has been tested. A valuation built on adjusted, evidenced profit is a firmer starting point for any conversation, including one with an adviser. For the sale process itself, see how long it takes to sell a business; for anything about your own deal, take advice.

Where teasr fits, and where it does not

Unlike a valuation tool, teasr gives no figure for what a business might fetch. Its free readiness check takes nine answers you can give from memory, including profit before add-backs, the add-backs you would claim, customer concentration and time away from the business, and names what a buyer is likely to question about them. It runs in your browser with no sign-up.

The Exit Readiness Report reads your documents, checks each figure wherever it appears, sets out your profit as you see it and as a buyer is likely to see it, and lists the questions to have answers ready for. You can read a sample report, and what it costs is on pricing. It is software, not regulated advice, and it is not an audit.