A Guide to Return on Investment

CAPITALISATION OF EBIT (Maintainable Earnings after management or fair owner's wage)

Leasehold Businesses Cap Rate Multiple
High Risk - e.g. blue sky, just established, projection only, declining profitability. *50 - 66% 1.5 - 2 x
Above Average Risk - e.g. specialist, restaurants, trade, building, fashion, seven days per week, no staff, established under three years. *38 - 42% 2.4 - 2.6 x
Average Risk - e.g. food, retail, manufacturing, service, 5½-6 days, mum and dad owners, some staff, growth up to 10% p.a. well established. *30 - 35% 2.8 - 3.3 x
Low Risk - e.g. high growth, wholesale, well systemised, managed, well staffed, five days per week, long established, high value assets. *25 - 28% 3.5 - 4 x
Corporate Appeal - e.g. fully managed, high profits, synergy in merger. *14 - 20% 5 - 7 x

The table above illustrates types of businesses and risk rates (there is a grey area between all, as some businesses can be deemed to be just above or just below average depending on the variables listed above).

Business owners should be aware of the features of a quality business that will attract a premium sale price. The typical premium Buyer wants to enjoy life as well as own a business. This Buyer wants as much disposable income as possible and the time off work in which this money can be spent, enjoyed or invested for future retirement.

The following features are ‘must haves' to be a quality business:
  • Full and growing financial records for at least 3 years.
  • Net at least $80,000 pa EBIT (after fair owner's or manager's wage).
  • Allow owner/operator to work only 5 days per week or less.
  • Continuing and reliable staff in place.
  • A minimum 7 year lease (ideally 10 years) at an acceptable industry rental.
  • Sales income not dependent on the personal relationships or skills of the owner.

Other features that will enhance the value are:

  • A well developed strategic business plan.
  • Written management and operations manuals.
  • Protected patents, designs and intellectual property.
  • Plant and equipment in good condition.
  • Good and saleable stock at efficient levels.
  • Suitably located and well maintained premises.
  • A niche market or high barrier to entry.
  • Well diversified customer base.
  • Genuine reason for sale.
  • Other synergetic businesses close by.
  • Full transition assistance from the Seller.

Cash Businesses

Business owners who take cash out from their businesses think they are smart but in reality if they have to sell quickly they can lose hundreds of thousands of dollars and end up far poorer in the long run. Any business that loses cash, whether to the owners back pocket or stolen by staff, will be affected at time of sale.

For example:

$1,000 per week lost = $52,000 pa

Tax saving at 30% = $15,600 pa

Value lost
@ 2x $52,000 = $104,000 pa
@ 3x $52,000 = $156,000 pa
@ 4x $52,000 = $208,000 pa

For every dollar per week that disappears, the value of the business can be reduced by up to $200. Who's smart now!

If a Buyer acquires a potential ‘cash reduced' business, he will be able to create an attractive capital gain after 12 months.

Finally, we should expand on a few tips to the Seller.
One of the Buyer's greatest fears is that the goodwill of the business will disappear when the owner leaves.
To minimise this fear the business owner must give more responsibility to the staff in all departments.
The more the business operates without you the better.

Business owners should also strengthen their industry networks and supply agreements.
They should maintain strategic relationships, develop partnerships and have written agreements in place.
A strategic supplier may become the best Buyer.

In summary, to achieve the best price on the best terms in the shortest and least stressful time, the business owner should understand the key indicators of value, make the business operate without the owner and have a long term lease at a fair rent or alternatively own the freehold premises.