There are plenty of good reasons for wanting to know how to value a business. Obviously, if you’re planning to sell in the immediate or near future, you’ll be keen to know how much you’re likely to get, but you may also be interested in establishing an accurate value so you can raise equity capital or create an internal market for shares. You may even want to benchmark your business’s current value so you can raise it to a level at which it’s worth selling.
Getting the asking price right feels like more of an art than a science and although there are formulas , you will have to apply a little common sense, too. Ask too much and you’ll risk squandering your fresh-to-market feel with the inevitable price cut a few months down the line. Go low and you could miss out on your rightful dues.
Where do you start with valuing a business?
In its most basic terms, the value of your business depends on the balance between its profitability and risk. Most valuations start with past profits and an approximation of the value of assets but the final figure is tied up in an number of intangibles like brand, staff, customer list and financial performance. If you are selling a business, your buyer will mainly be interested in past performance as a predictor of future performance but they’ll also be looking carefully at your prospects and will have a keen eye on long-term contracts and recurring-revenue streams.
What are you valuing?
It may sound like a stupid question – you’re valuing your business, right? Well, yes, but what’s on the table may differ depending on your company’s status – whether you run a limited company or operate as a sole trader.
Sole traders usually have a simple proposition – the trade with any equipment and stock, together with the transfer of lease agreements. Any profit on top of the value of these items is the goodwill value which may include the perceived value of your brand and customer portfolio. Limited companies have two options: selling the shares in the company or selling its trade – usually the customers, stock, assets and perhaps brand and website. When valuing, make sure you know what’s being priced up.
How to arrive at a business value
Arriving at a value will usually require in-depth analysis of company accounts, leases, contracts, and prospects as well as stock and other assets. Small businesses are commonly valued by adding a goodwill payment to the stock at valuation (SAV) figure, independently verified against the value quoted on the balance sheet. The circumstances of your sale may also be a factor on its perceived value. If you’re retiring because of ill health or emigrating, for example, you may be looking at a reduced value.
Business valuation methods
1. Adjusted net profit
The business’s total value will likely be based on a multiple of profitability. The simplest value calculation is to multiply your business’s annual adjusted net profit by a profit multiplier – which will vary according to your industry sector and economic conditions. If your company makes £30,000 profit (after subtracting the owner’s salary) before tax, a reasonable value might be to apply a profit multiplier of 3x to arrive at a figure of £90,000, for instance, giving the buyer a 33% return on their investment each year, or a price-to-earnings ratio of 3:1.
Obviously if the perceived risk is low or the business especially desirable with sustained profits or valuable intellectual property, the profit multiple is likely to be higher. Small businesses may have lower profit multipliers because they are seen as a bigger risk and shares can’t be readily traded.
2. EBIT & EBITDA
A variation of adjusted net profit, is your business earnings before interest or tax, referred to as the EBIT (Earning Before Interest and Tax).
Another variation of the above, is the EBITDA. Working in the same fundamental way as the EBIT, this calculation excludes any adjustments to your profit from depreciation or amortisation.
3. Asset valuation
The net-book value of your business is the total value of the assets minus its liabilities. You must take into account factors such as account inflation, depreciation or appreciation to ensure your assets are valued at the correct rate.
4. Discounted cash flow
This method estimates the predicted levels of future cash flow to value your business. Make sure you do a thorough job by incorporating likely rates of inflation: it’s sensible to use a discount rate of 15-25% when calculating projected rates of inflation.
Which valuation method should you use?
Valuing a business usually requires detailed analysis of company accounts, leases, contracts, and prospects as well as stock and other assets. Small businesses are often sold on the basis of a goodwill payment plus stock at valuation (SAV), independently verified against the value quoted on the balance sheet.
The total value of the business will usually be based on a multiple of profitability. The difference between that figure and the net asset value, including stock, will form the ‘goodwill’ part of the equation and will vary according to the type of company.
In most cases, assets are part of the overall business value, but for some companies, the assets may be worth more than the value of the business itself – especially in cases where profits are comparatively low and assets, like land or buildings, have a relatively high value. Conversely, service businesses which generate profits from the professionals who deliver them may have few tangible assets.
The simplest value calculation is a profit-based one: multiply your business’s annual adjusted net profit by a profit multiplier. If your company makes £50,000 profit before tax, a reasonable value might be £150,000, giving the buyer a 33% return on their investment each year. The adjusted net profit must take account of any salary the owner takes – or doesn’t take – so that profits aren’t artificially inflated.
Improving the value
It’s definitely worth trying to see if you can increase the value of your business by instituting simple changes. It will require a clear-headed analysis of every part of your organisation but could pay dividends on the bottom line. Simple things – like ensuring your paperwork is up to date and that customer contracts are in place – can make a big difference to saleability.
If your staff are hard-working, loyal and willing to work under a new owner, they’ll be an asset to the sale and may make transitioning the business easier all round. Conversely, if your business is too dependent on you manning the helm, you may be adversely affecting its value. A business that can demonstrate effective management with robust operational systems and a healthy customer pipeline will command a better price.
The big picture
The real value of your business is in its overall proposition – the brand, the product or service proposition, the location, the infrastructure, the knowledge base, the client list and the profitability. For further information on valuing your business and a guide to what your business is worth, view our business valuation calculator.