How Much Is My Business Worth? How Melbourne Businesses Are Actually Valued

Start with what value means

The question has a precise answer once you pin down what is being asked. The ATO describes market value as the amount a willing buyer and a willing seller would agree to in an arm's length transaction, based on the most valuable use of the asset. Its valuation guide traces this to the High Court's decision in Spencer v Commonwealth, which pictures a notional sale between a buyer and seller who are both fully informed, neither forced to deal.

So it is not what you need to retire on, not what one keen competitor might pay for reasons special to them, and not the price on a listing. It is the price the facts support in a fair market at a stated date, and a valuation report states that date and definition up front.

Step one: find the earnings a buyer can rely on

Most Melbourne small and medium businesses are valued on what they earn. The valuer starts with the profit and loss for the last three years and the current year to date, and asks of every line: will a new owner keep getting this, or keep paying this?

That produces a set of adjustments, often called normalisation. Personal expenses run through the business come out. One-off costs, such as a legal dispute, a fit-out repair or a bad debt from a customer that has since closed, are removed. A one-off windfall, such as a large job that will not repeat or a government grant, is removed too. Rent paid to a related party, often a family trust that owns the premises in Moorabbin or Bayswater, is reset to a market rent.

What is left is a view of maintainable earnings. It is usually a weighted figure across several years rather than the latest year alone, unless there is a clear reason the latest year is the new normal. A Smith Street café's record year while a neighbour was closed for renovation is not necessarily the new normal.

Step two: pay the owner properly before valuing anything

Many owners take a low salary and draw the rest as profit. A buyer still has to replace that work: if the owner is the head chef, the lead electrician or the person who quotes every job, the buyer either does it (and expects to be paid) or hires someone.

So the valuer sets a market wage for each role the owner performs, including superannuation, and deducts it from earnings. Family members paid below market are corrected too, and owner pay above market is added back. What is left is the profit the business makes for its owner as an investor. Skipping this step is a frequent reason an online estimate comes out higher than a signed valuation.

Step three: capitalise the earnings at a rate that reflects risk

Once maintainable earnings are set, the valuer converts them into a value by applying a capitalisation rate, which can be expressed the other way round as an earnings multiple. A riskier business gets a higher rate and a lower multiple, because a buyer wants their money back sooner.

The rate is a judgment, but it has to be a reasoned one. The valuer looks at how long the earnings are likely to last, how much depends on the owner, how concentrated the customers are, how secure the lease is, how the industry is tracking and what evidence there is from comparable sales. The ATO's guide asks valuers to explain why the chosen method suits the asset and recommends a second method as a cross-check where possible. A sound report shows both, and explains any gap between them. You should never see a multiple in a report with no reason given for it.

Step four: from business value to what the owner receives

1. 1.Start with the value of the business as a going concern, built on capitalised maintainable earnings. This assumes the business keeps the plant, equipment and working capital it needs to trade.
2. 2.Check working capital. If stock, debtors and creditors sit at an unusual level at the valuation date, the valuer adjusts for the excess or shortfall against a normal level for that business.
3. 3.Add surplus assets that the business does not need to earn its profit, such as excess cash, an investment property or a loan owed to the company by a related party that will be repaid.
4. 4.Deduct interest-bearing debt, such as bank loans, equipment finance and loans from shareholders that must be repaid, to move from the value of the business to the value of the equity.
5. 5.Apply the ownership interest. If the valuation is of a part share, the rights attached to that share and any agreement between the owners can change the figure, and the report says how.

What makes a Melbourne business worth more or less

Why online calculators and rules of thumb mislead

A calculator applies a general multiple to a revenue or profit figure. It cannot see whether the profit includes the owner's wage, whether one customer is half the revenue, or whether the books match the BAS. It cannot tell a Fitzroy restaurant on a new ten-year lease from one in its final year.

Rules of thumb, such as a percentage of turnover or a multiple of weekly takings, have the same problem in a different form. They are averages taken from deals with unknown facts, often passed around without a source. Two businesses with identical turnover can have very different profit, and value follows profit, risk and assets, not turnover. A rule of thumb can be a sense check beside the main method, never the method itself. Treat a calculator result as a rough first range.

Victorian matters that can change the answer

Three Victorian issues come up again and again. The first is the lease. For a retail lease, the VSBC says a landlord can withhold consent to a transfer on grounds that include the incoming tenant's financial resources and business experience, and that on a sale of an ongoing business the tenant must give the incoming tenant three years of business records. A business that cannot pass its lease to a buyer is worth far less to that buyer.

The second is payroll tax. The SRO's grouping rules treat businesses that share ownership, control or employees as a single entity, so they cannot each claim a tax-free threshold. A buyer who owns other businesses may face a different payroll tax cost from the seller. The valuer records the position your accountant gives.

The third is land. If the business entity owns Victorian land, a sale of shares or units may bring landholder duty into play where the land holdings are worth $1 million or more, according to the SRO. The land is valued by a property valuer in Victoria; the business is valued on a market rent basis so the two do not overlap. Whether any of these taxes or duties apply to you is for your accountant, lawyer or the SRO, not the valuer.

• ·Market valuation of assets, Australian Taxation Office
• ·Market valuation for tax purposes (guide), Australian Taxation Office
• ·Transfer of a retail lease premises, VSBC (vsbc.vic.gov.au)
• ·Payroll tax, State Revenue Office Victoria
• ·Payroll tax grouping, State Revenue Office Victoria
• ·Understanding landholder duty, State Revenue Office Victoria

This guide explains how valuations work. It is not tax, duty or legal advice: those positions are for your accountant, lawyer or the relevant regulator.