How do you determine the value of a small business when it’s less than ten years old? This is the question that challenged Adrian and Andrew* when their relationship as co-founders of a small, Singapore-based consultancy broke down. They didn’t want to close the business because it was running successfully. They decided instead that one should buy the other out. But at what cost?

“The decision to part ways was simple but the negotiation to determine the company’s value was long and incredibly painful,” admits Adrian. “I wouldn’t want to go through that process again.

This situation is not uncommon. Co-founders often feel the desire to split up and do their own thing, leading to their shared business being bought out, or closed down if it’s not doing well. It is also common for company owners to want to sell early.  In fact, only a third of businesses reach their 10th birthday.

“Valuing any business presents challenges because the calculation is subjective”, says Marc Leong, Head of SME Banking at Maybank Singapore. “But valuing a small business is especially difficult, because the main things buyers look at are financial and it can take companies years to build their revenue and profitability levels. We work closely with SMEs as their trusted advisor – that is our differentiator – as we know that even the best business ideas can take years to blossom.”

Small business founders are usually reluctant to sell too cheaply in the early years because they have faith in the company’s potential. On the other hand, investors can be hesitant to pay too dearly for a business that is immature and carrying greater uncertainty than a larger, older company.

As Asia’s leading banking group since 1960, Maybank supports a large number of small companies. By encouraging a culture of open and friendly relationships with clients, it has helped many of them to understand which financial indicators are going to be important in determining the health of their business if, and when, the time comes to sell.

“We work with a lot of SMEs and understand what their business means to them! They’re giving everything they can to grow their business. We delight in our clients’ passion for their companies. This excitement and commitment are very important. At the same time, we provide guidance in areas like financial discipline, liquidity management and optimal levels of leverage for operational efficiency and long-term sustainability,” said Mr Leong.

One of the measures that Maybank encourages small companies to think about is their cost of sales, because potential investors want to feel confident that they will be able to produce their core products cheaply enough to make profits as the business expands, even if they aren’t profiting in the early years.

Accountants refer to this as the ‘contribution margin’ and it’s a term that small business owners should be aware of. Contribution margin means ‘revenues minus variable expenses’. It refers to the amount of profit you make on the products you sell, before you factor in overheads like salaries, shop or office rental, telephone bills, marketing etc. Maybank encourages small businesses to think about this cost because as long as this margin is satisfactory then the business should become more profitable as it grows.

Adrian used this accounting knowledge to her advantage when he was negotiating to buy Andrew’s share of the business.

“I was able to explain to Andrew that our contribution margin was too small.  In short, we weren’t making enough money for any investor to be confident enough to buy us at that time. When he realised he couldn’t expect me to pay too much for the business, he dropped his price and I bought him out for the small amount that I could afford.”

The ‘contribution margin’ is just one of many things investors look at but it’s an important one. The most important thing is that small businesses know their business inside out – exactly how much they are making and exactly how much it is costing them. 

“What we love to see is a business owner who is passionate, hard-working and who also cares about getting the business model right. When we see these great traits in an entrepreneur, we feel very confident and share their excitement as we lay our support for their journey,” said Mr Leong.

Key take-outs:

• Even in the early years of your business take notice of your contribution margin – the amount of profit you retain before you spend money on overheads - because this is a good indicator of the viability of your business
• Know that valuing a business is subjective and will depend on the reason the investor has for buying the company
• Seek guidance from your bank so you can grow your business from the outset in a way that will make investors feel more confident in its potential, if and when you decide to sell. 

If you like this article and wish to know more, connect with us here.

To help SMEs tide over this challenging period, Maybank, as Asia’s leading financial institution since 1960, offers SME Loan Repayment Relief Package and provides support to Medical Care and F&B Merchants. Click here to find out more.

*Names changed for anonymity.

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