What is Honey G’s recruitment business really worth?
Earlier in the week the Daily Mail suggested that ARG Search Ltd, X Factor contestant Honey G’s business was worth £1. Information in the public domain is limited but the one thing you can definitely say is that it is very unlikely to be actually worth £1.
For the last 2 years the Net Assets (assets less liabilities) have equalled £1. But you cannot see turnover, number of clients, candidates, open roles on ARG Search’s books and many other business details that affect valuation.
UK accounts value everything (well almost everything – this blog is not intended to keep technical accountants and auditors salivating) at cost. Future potential, changes of value due to inflation/deflation are not shown and the vagaries of the free market economy are ignored.
Honey’s full accounts will show turnover and the amount she has taken out. She may have taken £1,000 or £100,000 and arranged it so that what was left was only £1.
So how can you arrive at a ball park figure?
Listed companies have an ‘open market value’ (OMV) as the shares are stock market listed. Investors understand what they are buying and in the future the shares will increase in value.
So how does this work for businesses too small to be listed?
Of course this could be anything, but in practical terms it means that you remove the pay, bonus, pension, dividend, drawings, loans – anything of value that the business owner takes and any expenses that were mainly his.
This could be an expensive car, a phone or PC. A restaurateur may have a lot of in-house meals and entertainment. Charitable donations need also to be reviewed for realism. There may be family members employed at unnecessarily.
This is typical behaviour for business owners looking to keep taxes to a minimum and enjoy their businesses while running them.
If the purchaser is going to work in the business post-acquisition, then it is on this adjusted figure that he will calculate the expected return and is the amount from which the new owner will draw. If he or she has to borrow to fund the purchase, then this surplus has to fund the owner’s living costs and service the loan.
Depreciation and amortisation should be added back to get to a more ‘cash equivalent profit’ but new businesses have these non-cash costs too so they will not disappear completely. Every business has fixed assets which need replacing and provision must be made.
One-off non-recurring costs should be removed; new websites, new IT systems etc major repairs.
The change in profit can work both ways. A business may look initially very attractive but if the owner is taking minimum wage and their family is working for next to nothing then the real profit is much reduced as will the sales price be.
An investor will add the cost of a manager to the expenses and then use the resulting profits to decide whether the investment returns will be sufficient to justify the purchase price.
So now you have adjusted profits. This is not the value. Unlisted businesses sell for somewhere between 1 and 4 times the adjusted profit. This is called the multiplier. Finding the right multiplier is really more of an art than a science because it varies depending on the industry, market risk, company size, and the business’ tangible and intangible assets, independence from the owner, and many other variables.
“Owner risk” is the biggest influence on the multiplier. Businesses highly dependent on the owner may transfer the business’ assets easily but the clients and intellectual knowledge are more difficult things to pass on. If the owner’s influence cannot be easily transferred, the business’ valuation will suffer.
Market risk can be minimised by never buying into a business in an industry you do not understand, irrespective of the management team in place. If you’re buying or selling a business in a sector that is expected to grow, the multiplier will be higher.
For a more accurate estimate of the multiple, consult a business broker or appraiser but your accountant (or one who has knowledge of your industry) should be your first call.
Add Other Business Assets and Subtract Business Liabilities
The final step in valuing a business is to account for assets and liabilities that aren’t already included in the multiplier. Most small business deals are “asset sales” so that the purchaser buys a bunch of assets and, typically, the seller retains liabilities – the shares stay with the seller. What is purchased will vary from sale to sale.
If the multiplier valuation comes to £100,000 and the basic business asset values are £75,000 then the Goodwill or Premium would be £25,000.
If the business also owns other assets, for example a property that is for sale, then this value would be added to the £100,000 in the same way that any transferred liabilities would be deducted from the overall sale price. For example BHS was sold for only £1 because there was a £571m pension scheme liability!
Look Beyond the Past – Create a Business Plan
Using multipliers to value a business is grounded in reality but also (ancient) history. The purchaser needs to be clear that the price he is paying allows him to generate value over and above annual profit in the medium term. In 5 years he would want to think that another sale would generate more than the £100,000 originally paid.
A buyer must consider factors that might be challenges and opportunities for the business going forward in much the same way that you buy property that will gain in value during your ownership while you also have the benefit of using it but may have to out in a new boiler!
In particular, you must have a clear plan for what will change under your ownership. Your business plan should look forward at least 3 years and should plan for the impact of the changes you expect to make.
Take emotion out of the valuation process
Sellers need to have reasonable expectations about price. We often see unrealistic expectations because it is ‘their baby’ and all the hours, blood, sweat and tears expended should clearly command top dollar.
Sellers should agree a minimum value and then speak to a professional who can carry out an impartial valuation. It is always best to be realistic because the costs of the process are not insignificant and should not be incurred unnecessarily.
On the flip side, buyers too have unrealistic views of how they will be able to run the business. They believe they can turn around losing ventures easily. “I can do better is the mantra but buyers should remember that certain things about the business, location and competitors, cannot be changed even when they take over. These things need considering when agreeing price.
Using a simple but effective multiplier and taking professional advice is vital to a successful deal.
Back to Honey G
So without a detailed look at the underlying records it is not possible to value ARG Search Limited in any meaningful way. All that can be said for certain is that its value will not be £1.
Azuki is a specialised accountancy firm that has considerable experience in buying and selling recruitment firms and can provide that comfort that you are making the right decision for your business.