Service Businesses: The Challenge of Valuation

The torso of a man in a business suit, seating at a desk with a laptop computer, scattered papers, and a glass of water.

Service businesses are used to monetising the intangible. Putting a price on skilled counsel might be difficult. But putting a price on the enterprise that delivers it is even more so.

Although few valuations are based entirely on physical assets, with a service business, these play even less of a role. Instead, the valuation is based on a simple equation. The investment someone will be willing to make in your business is founded on your future maintainable earnings multiplied by the capitalisation rate. This method, as it uses profit as a key factor, is commonplace for profitable businesses.

When you are demonstrating the future maintainable earnings of a business, you will be basing it on the past. This means sifting through financial statements and making relevant adjustments. These adjustments are to ensure that they are the most accurate prediction of what might occur in the future. Your imperative here is demonstrating strong and recurring profit.

The capitalisation rate takes into account both the prospect of business growth and the risk associated with the business. Potential buyers will assess risk and growth potential via a wide range of factors. Is the business operating in a sector of growth? Or is it a so-called “dead industry”? Here, the ‘intangible’ also comes into question in relation to staff quality. Does your business have skilled, experienced staff working within it? Will they be retained on the sale of the business? Have you and those staff built effective and resilient systems and processes by which the business is run? Are those processes documented?

Another question particularly pertinent to service businesses is their client base. Is it strong, large, and loyal?
Closeness to clients is an important part of very many service businesses. And it’s also an important part of revenue: if a loyal client base is what is keeping your business alive, and they will abandon if the business is sold, this is hardly a ‘maintainable earning”. It goes without saying that this impacts the capitalisation rate.

This is sometimes why businesses are sold to the “best fit” purchaser, rather than the highest bidder– to help preserve those essential client relations that are – after all– the drivers of revenue.

To understand the value of your skilled counsel, it pays to seek further skilled counsel. We specialise in dynamic valuations that highlight the drivers of your value– so we can work together to drive it higher. Starting the conversation about valuation is as easy as grabbing a cup of coffee. Give us a call, and we’ll set up a time to start discussing the bright future of your business.