Valuing your business is a useful exercise for lots of different reasons – not only if you want to sell. Knowing the value of your business can give you a foundation to build on and help you come up with a plan for the future.
Because valuing a business is more of an art than a science, we’ve put together this guide to cover everything you need to know and make valuation as easy as possible.
In this guide:
Why value a business?
An accurate business valuation is useful in a number of circumstances.
1. Selling your business
Chances are, the main reason you want a valuation is to sell your business and for the purpose of this guide, that’s what we’re assuming. Other than giving you a ballpark asking price, here are some other ways knowing your business value can be useful.
- It can help you establish a base on which to improve the value (something that may be useful even if you’re not intending to sell).
- It can help you make a decision if it’s a good time to sell - if not consider improving the value?
- Allows you to negotiate better terms with your buyer.
- It can speed up the purchase although a buyer may want an independent valuation.
2. Attracting investment
Your business might be thriving and so you may have decided to expand and attract new investors or release additional shares. A business valuation will give you guidance in setting a realistic price for either of these scenarios.
It’s basically just like Dragon’s Den, you have a figure in mind that you’d like and a business valuation helps to back this up.
3. Incentivising management and employees
A business valuation can also help you set goals and incentivise management and employees. Whether you choose to create a reward scheme based on increasing the value or zone in on areas of the business that need improving, an annual valuation can help you improve your business and increase its value.
4. Estate planning
Finally, a business valuation is useful for planning for the future. An up-to-date business valuation will help you get your affairs and assets in order so that your beneficiaries can make informed decisions in the event of your death.
What affects a business valuation?
There are certain factors that are guaranteed to have an impact on your business’ value.
The circumstances in which you’re selling your business can have a huge impact. If you’re able to take your time and aren’t in a rush to sell, you won’t have to settle on the asking price. However if you need a quick sale, buyers will be in a better position to negotiate. So when it comes to valuing your business, realistically consider your position and adjust the value accordingly.
For example: An owner-manager who wants to retire will be in a better position to sell than an owner-manager who has been forced to sell because of an unexpected illness
Tangible assets are any buildings or property that you own and can be sold. These are factored into your overall business value.
You will have more tangible assets if you own a lot of your equipment or the space you operate out of. For example, if you own a bakery your tangible assets will be everything from your ovens and fridges to mixers and display stands.
However if your business is based predominantly online or you offer a service instead of a product, it’s likely you’ll have few tangible assets. In which case future profitability will become a larger factor in your business valuations.
The age of your business
A lot of businesses make a loss in their first few years and have negative asset value, so your age can influence the value of your business.
If your business is established and has been trading for several years, you’ll have had the time to build up a customer base, grow your reputation and have the accounts and cash flow to base your value on.
However if you own a young business, you might not have any of this but it doesn’t mean your business isn’t valuable. As with businesses with few tangible assets, your value is all wrapped up in your future profitability.
What kind of company status are are you valuing?
It may sound like a stupid question but understanding what to include in your valuation could have a surprising impact on your value. What you value depends on your company’s status – whether you run a limited company or operate as a sole trader.
Sole traders usually have a simple proposition so working out a value is relatively easy. The trade with any equipment and stock, together with the transfer of lease agreements makes up the value. Any additional cost on top of the value of these items is the goodwill value. Goodwill can include things like the value of the businesses name and reputation, solid customer portfolio and good employee relations.
Limited companies have two options: selling the shares in the company which represent the assets and goodwill, or selling its goodwill and assets separately. The goodwill is usually the customer portfolio, stock, assets and perhaps brand and website.
Regardless of your company status, it’s important to make a note of exactly what’s included in the valuation and break it down bit by bit. This will make it easier to justify the asking price and will also make it obvious to buyers exactly what they’re purchasing.
If your buyer opts to buy the goodwill and assets rather than your shares, you would clear the liabilities in your company and dissolve it.
So now you know why you should value your business and what impacts its value – just how do you go about valuing it?
How do you determine the value of your business?
To get an accurate business valuation, you need to spend time looking carefully at your company accounts, leases, contracts and prospects as well as stock and other assets.
If you want to value a small business, it’s common practice to add a goodwill payment to the stock at value (SAV) figure and then have this independently verified against the value quoted on the balance sheet.
So to help you arrive at that figure, here are some methods to use.
1. Asset valuation
As we’ve already mentioned, the net value of your business is the total value of its assets minus its liabilities. So this means if you have outstanding debts then your assets are worth the total value minus the debt you have to repay.
Start with all the assets that are stated in your accounts to figure out the Net Book Value (NBV) of your business. You need to then realistically refine the NBV figures for major items and consider account inflation, depreciation or appreciation. For example any stock you have that will need to be sold at discount would be valued at the discounted price.
This method is best used if you have a stable business with plenty of assets. It doesn’t take into account any future earnings but can form part of a larger method for determining value.
2. Price earning’s ratio
The price earning ratio (a profit-based value) is the value of the business divided by its profits after tax. You can value a business by multiplying the profits by an appropriate price earnings ratio.
The ratio is normally for public companies as it’s worked out using the stock price. The higher the ratio, the more successful the business.
The ratios are roughly:
- 0 to 2.5 for small owner-managed businesses
- 2 to 7 for businesses with profits up to £500,000 a year
- 3 to 10 for small businesses with profits over £500,000
For example if your company makes £50,000 profit before tax and has a ratio of two, the value would be £100,000. This helps you to show the return on investment without worrying about inflating the figures.
3. Entry cost valuation
An entry cost valuation is useful if you want to start a business from scratch as it gives you an idea of what it would cost. It can also act as a very basic figure for valuing your existing business, but some of the other methods we’ve talked about are better suited.
To work out the entry cost valuation, you need to factor in absolutely everything that has gotten your business to the point it’s at.
- Unavoidable start-up costs like fees for obtaining certain licences or legal expenses
- Tangible assets that you’ve had to buy in order to operate
- The cost of advertising and marketing budgets in order to develop a customer based
- Product development
- Recruiting and training staff
Once you have a list of all the essential costs, think about where savings could be made. For example you may rent premises in a cheaper area, pay staff the national living wage, or source cheaper suppliers.
Once you have this number, subtract it from the original start-up figure for your entry cost.
4. Discounted cash flow
This is a very technical way to value your business and is based on assumptions about long-term business conditions. It’s best suited for cash-generating businesses that are stable, mature and predictable – like utilities companies for example.
The valuation is based on expected future cash flows – not just months later but years down the line. It’s calculated by adding the dividends that are forecast for roughly the next 15 years plus a residual value at the end of the period.
It’s based on the assumption that £1 today is worth more than £1 tomorrow. So to account for inflation, you should apply a discount rate of between 15 and 25 per cent.
This method of valuing your business isn’t suited to small or medium-sized businesses so we won’t go into greater detail. But if you’d like to know more about working it out, check out this guide.
5. Rules of thumb
In some industries, buying and selling businesses is common practice and so has led to the development of industry-wide rules of thumb.
These rules of thumb aren’t solely based on profit. They include the turnover for a certain type of business, the number of customers and the number of outlets. Looking at each of those factors helps to determine a value.
Of course, a buyer also has to consider what value the business would have for them. They may have a vision for merging businesses or decide that your business has a lot of potential in which case it would be worth the asking price.
6. Intangible assets
Intangible assets can also contribute to your businesses value. These are assets that can’t be measured such as:
- Strong relationships with customers
- Management stability
- Business reputation
- Business trademarks or patents
- A good relationships with suppliers
So if you have key employees or suppliers, ensuring contracts are secure and there’s a clear direction and explanation of the relationship will have a positive effect on your business value.
What valuation is right for your business?
The right method for you to use will depend entirely on your business circumstances. There will be some methods that you won’t be able to use as your business won’t match the required criteria
It is worth noting that each valuation method will likely produce different results, so it may be worthwhile trying a couple to give you a rough estimate.
Alternatively you could use a business valuation calculator to work it all out for you. This will help to give you an idea of what your business is worth and you can take it from there.
We understand that after all the hard work you’ve put into your business, you naturally have a figure in your mind that may be worth more than a buyer is willing to pay for it.
It’s important to take the emotion out of valuing your business. Ensure that you’re being sensible about the value of your intangible assets and don’t overvalue them.
The easiest way to take emotion out of valuing your business is to get a third party to do it for you. This way, you’ll arrive at an accurate figure without worrying about getting the maths right.
How to maximise your business value
There are some effective long term fixes you can put in place in order to boost your business value.
Remove yourself from operations
This isn’t always practicable, however the principle that the less you are relied upon as the operator of your business, the more valuable an opportunity you must sell. Even if you cannot be completely remove from day to day operations, you can document all your processes and delegate certain tasks to members of staff.
Preparation is key
You should prepare for a valuation in the same way you would prepare to actually sell your business. So make attempts to pay off any debts, ensure your finances are in order and review any contracts that are nearing their end.
Consider your future
Don’t forget that the future of your business can have an impact on your value just as much as the past does.
A business that’s breaking even won’t be that appealing to a buyer, unless it has a lot of potential in the future that is.
Work to boost your profits by increasing sales and lowering expenses where possible. It’s certainly a longer term approach but will make your business appear more efficient and profitable.
If you’re toying with selling your business, the best thing you can do is put together a plan and be strategic when you choose to sell. Your plan should include measurable goals and key milestones that make it clear when the right time is to sell.
So whether you want to value your business to help motivate staff or to give you an idea of what asking price to set, obtaining a business valuation is a useful exercise that can help you benchmark your business.
To save you time, we can value your business for you so you can focus on the day-to-day tasks. Just fill in your details and we’ll provide you with a valuation that helps you decide what your businesses future looks like.
Alternatively, you can use our instant online business valuation calculator for a guide price.