Whether you are looking to secure funding to help your business grow or thinking of selling up, this guide will explain how to value your business.
Why value a business?
Carrying out a valuation of your business is a great way to examine the financial health and moneymaking potential of your business. As well as this, there are plenty of other benefits that come part and parcel with valuing your business.
If you’re looking to secure additional funding for your business, it can provide investors with a realistic estimate of the value of your business and can help with settling on a price for issuing new shares.
A valuation can also help to trade shares in a business at a reasonable price.
It can give you a clearer overview of the financial health of your business, which can help you to pinpoint underperforming areas and focus on the approaches that are working well.
If your staff want to buy or sell shares in your business, valuing your business can help you set a fair price.
Valuing your business isn’t just about offering a snapshot of the profit and loss of your business, it can give a detailed overview of your company’s chances of sustainability over a prolonged period of time, which can offer incredibly helpful insight.
What affects the value of a business?
Lots of variables affect the value of a business, such as brand reputation, competitors and the wider economy. Other key determinants include:
If you or your management team have a strong record of steering the business in a successful direction, then this can have a positive impact on your business’ value. And if you have a band of loyal, experienced staff who are likely to stick with your business through thick and thin, this can cause your business’ value to rise too. It’s also a good idea to consider how much the success and longevity of your business depends on your skillset. If you think your business would sink without your captainship, this can prove risky and cause your business value to slump.
If you’re hoping for a favourable business valuation it’s important that your business’s finances add up as they should. Detailed records showing how you’ve business managed costs, well-evidenced past, present and future cashflow and profit projections, and the level of debt you’re currently in can all have an impact on your business valuation.
Age of the business
An established company’s profit versus an emerging company’s negative asset value.
Your business’ intangible assets play an important role in its overall value. From your company’s growth potential and reputation, to trademarks, intellectual property and the strength and profitability of your company’s relationship with customers and clients, each has an accumulative impact on your business valuation.
The physical assets that you’ve acquired to help with the day-to-day running of your business can also boost your business valuation. This includes assets such as your business premises, equipment – including computers and tools – stock, and the number of clients and customer you have.
The market your business operates in
The general condition of the economy, including interest rate levels and the overall demand of your business’s services, can affect your business valuation. A saturated market, with many businesses like yours operating in the same space, can devalue your business, while a large number of people expressing interest in the sale of your business can push the price up.
The circumstances surrounding the valuation can influence value; for example, compare a voluntary sale and a forced one.
Fundamentally, the value of a business will be how much a buyer is willing to pay for it. To reach this figure, you can use a number of valuation techniques.
How do you value a business?
Now that you know what can cause the value of your business to rise and fall, it’s time to examine the steps you can take to get an accurate understanding of the value of your business.
There’s no one fixed way of working out the value of your business, it’s more a case of testing out which options sits best with you. But always remember: the true value of your business is how much someone is willing to pay for it.
1. Asset valuation
If your business has sizable assets, then an asset valuation could be an ideal way to get to grips with the overall value of your business.
There are two types of asset: tangible and intangible. Tangible assets are the physical things belonging to your business, such as your business premises, stock, land and equipment. Intangible assets are any non-physical assets, such as your business’ brand, reputation and intellectual property including copyrights and patents.
To get the Net Book Value (NBV) of your business, you subtract the costs of your business liabilities (such as debt and outstanding credit) from the total value of your tangible and intangible assets.
It’s a good idea to regularly update records of your assets so that their value takes inflation, depreciation and appreciation into consideration, to help keep your asset valuations accurate.
Often, this asset valuation method yields the lowest value for a business because it doesn’t take into account any ‘goodwill’ towards the business – a technical accountancy term that covers the difference between a company’s market value (what people are willing to pay for it) and the value of its net assets (assets minus liabilities).
2. Industry best-practice
Not all industries are created equal. And for some, the buying and selling of businesses may be more common than in others.
The industries where the selling of businesses take place frequently – such as retail, where business turnover, customer volume and outlets are key indicators of value – might have specific rules of thumb that you can use as a guide to lead you through your business valuation process.
3. Entry valuation
An entry valuation framework model values a business by working out how much it would cost to establish a similar business. Essentially it’s asking ‘if my business didn’t exist, how much money would it cost to start it from scratch, right now?’
A good way to get an accurate estimate is to create a list detailing start-up costs, the price of acquiring tangible assets, employing and training staff, establishing a customer base, and developing products and services.
Once you have this costs list in place, consider how you could be as thrifty as possible when setting up. For example, you might be able to save some of your hard-earned cash if you set up your business in a cheaper location or opt for more cost-effective equipment.
After working out these savings, subtract them from your projected start-up costs. Ta-da, you’ve worked out the value of your business based on your entry valuation cost!
4. Discounted cash flow
The discounted cash flow method is one of the trickiest ways of valuing a business.
This is an income-based approach to business valuation that’s focused on working out what a future stream of cash flow is worth today. It tends to be used by established businesses who project stable, predictable cash flows for the years ahead.
To work out the present value of future cash flow, you apply a discount interest rate, usually between 15% to 25%, to cover any risk (such as unexpected costs or bills) and the time value of money. The time value of money is the idea that £1 earned today will be worth more than £1 gained tomorrow due to its earning potential.
To reach an estimated business valuation, you add the projected takings forecast for the next 15 years or so, plus a residual value at the end of the period. If your estimated business valuation is higher than today’s investment, then it’s likely that this is a business investment worth keeping in your sights.
5. Comparable analysis
An easy but popular approach to valuing your business, the comparable analysis method involves assessing the value of businesses similar to yours that have recently been sold or whose business valuation is currently common knowledge in the public domain.
Comparable analysis gives an observable value for your own business, based on what rival or similar companies are worth at present.
6. Price/earnings ratio (or the multiple of profits)
The price/earnings technique is suitable for businesses with a solid track record of profitability.
- Adjusting monthly or annual profits to exclude extraordinary events, such as one-off purchases or costs so that you’ll get a pretty good idea of future profits
- Adding further costs or gains the company makes after it’s been sold or invested in, which produces a final profit figure (called normalised profit)
- Multiplying normalised profit by three to five (which is the standard industry practice)
- The resulting figure is the price-earnings ratio. Commonly accepted earnings multiples range from a modest one times earnings (doctors’ offices) to a whopping 25 times earnings (banks or hot tech startups).
7. Entry cost
The entry valuation model values a business by estimating the cost of starting up a similar business from the ground up.
You’ll need to calculate the cost of employing people, delivering training, developing products and services, building assets and a client base. The whole shebang, really.
How can I secure a good business valuation?
Valuing a business is as much an artform as it is a science. Thankfully, there are plenty of easy steps you can take to help secure the best business valuation possible.
Have a solid business plan
This might sound obvious but having a business plan in place which clearly outlines how you’re going to meet short-term and long-terms – and by extension, bring in those all-important profits – is a simple but effective way to show investors and buyers that your company’s potential is in good hands.
Get your finances in order
The last thing you want is a poor record of your business’ cash flow putting off potential buyers or preventing you from getting an accurate business valuation.
Before you start the process of valuing your small business, it’s a good idea to get your finances in tip-top condition to ensure you’ve got firm financial foundations. Keeping the following documents, in a safe, easy-to-reach place could help make the process of valuing your business that bit easier:
- Profit and loss statements (at least three years’ worth)
- Tax filings and returns
- Records of purchases
- Licenses, deeds and premises documents
- A regularly updated overview of your business’ finances
- Credit reports
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- Keep risk to a minimum
As well as investing in business insurance to protect against accidents that could bring your business to an unexpected standstill, there are some simple steps you can take to minimise risk.
For example, it’s a good idea not to solely rely on working regularly with the same clients and customers, as a change in circumstances could bring this working relationship – and the associated income stream to your business – to a sudden end. Instead, having a wide-spanning network of customers and clients can help to minimise risks like this.
Don’t overestimate your business’ value
You’ve worked hard to get your business into the shape it’s in today. However, it’s important that you don’t let your pride in your company cloud your judgement and cause you to overestimate your value – especially as steep asking prices can put off potential buyers and investors.
Keep a sensible head when valuing your business so that you reach a price that’s not only reflective of the hard work you’ve put in, but one that’s accurate and enticing to investors or buyers.
Flex your negotiation skills
Not everything of value can be measured. But when it comes to the value of your small business’ intangible assets, it’s your responsibility to promote their worth to capture the attention of buyers.
For example, if you have a good relationship with customers and suppliers, or have loyal employees, it’s important that you factor these assets into your valuation if you’re selling it on or using it to secure further investment.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal or financial advice, nor is it a complete or authoritative statement of the law and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert legal or other advice should be sought.