Finally, I arrived at the Big One, the valuation: my aim is to value a business on 5 times Maintainable Earnings, profits excluding one off items that don’t relate directly to the business such as costs of looking at other acquisitions.  So on day 1 they will pay this, to the founders, and each year after, for 4 years, they will pay 5 times the profit for that year LESS the amounts paid in previous years. Another win-win in my view and crucial for getting nexus: a point at which our aspirations actually meet (touch) their view.

I needed to refine this and check it with someone so off to meet my accountant. He put me right on maintainable earnings and surplus assets:

1. I had added back salaries of the founders but hadn’t deducted an economic sum for staying in the business – ie, what would the purchaser have to pay to hire people to do the job of operating the business. We came up with £75k a head salary.
2. James had said that we could add assets on to the multiple of earnings. My accountant said that we could only add on surplus assets – ie, cash that isn’t required to fund the working capital and investments that we have acquired over the years.

So I adjusted my figures accordingly and we discussed the earn-out period and the multiple.

We went for a four-year earn-out because it’s long enough to really be able to grow the business, which is what everybody wants, and by 2016 the economy should be in a better place than it is now. It shows that we are serious about not walking away and we have every chance of getting the maximum value for the business. This is what Steven Covey calls “win-win”.

You can wax lyrical about financial theories, but there are only three multiples that apply to the profits of decent mid-sized businesses:

• 4 – if it’s a bit weak, or young…or old
• 5 – if you can make a strong case
• 6 – once profits are £1m and the business is still sound.

For public companies, tech companies that can grow hugely, and mega-companies, then you might be able to improve on this but if, like us, you’re not one of them, then my advice is: just think 5 not 4.

My accountant and I relied on three factors to justify 5:

• Scalableability – we have branches and new businesses coming from the core business,  which are all doing well
• Reputation – brand is a bit high falutin’ until you’re really big but a good name has value. We are well known, been around a long time and people do just call us and ask us to work for them
• Low risk: we have a simple business model, we don’t make mistakes and even if we did we could correct them pretty easily.

All that should justify a 20 per cent return on investment, rather than 25 per cent for the purchaser.

I then showed this to my tax adviser. He needed a nudge but after a week he gave me the okay. He said that heads of terms don’t usually survive first contact with the lawyers but I’m determined to keep this deal on track and not be railroaded by the acquirer.

More in the coming days. Register here for the Real Business newsletter, and you’ll receive my updates direct.

If you’d be interested to talk to our mystery vendor direct, email or tweet the Real Business team. 

Share this story