Valuing a business is a challenging process that all business owners will face at some point during their business life cycle. But this blog is designed to help you!
A business valuation helps you to clarify the expected market value of your business. This is usually determined using a range of measures in order to find the economic worth of the business. Sometimes the economic worth might not be relevant if your intangible value is perceived to be higher. However, this is useful for entrepreneurs and small business owners looking to buy, raise capital or sell a company.
Here are the key factors that determine the value of a business:
- Net Assets of the business
- Trademarks, Patents & Rights owned by the business
- Turnover and profits
- Business Reputation
- Value of Customers
- Future business opportunities
- Strength of the team
- Age of the business
- Circumstances for the valuation (liquidation, sale, fund raising etc)
How do you Value your Business?
There are multiple methods of valuing a business. The method used will depend on number of factors. In some cases, more than one approach is used or even a combination of them.
Valuing the Assets of the Business
Most established businesses with a lot of tangible assets are often suited to being valued on these assets. Good examples of businesses like this are those in property and manufacturing. These businesses can be easily valued by working out the Net Book Value (NBV). Netbook is the difference between all assets and liabilities. In essence, if all assets were sold and liabilities settled what you would the value left within the business.
Price to earnings ratio
Price earning also known as P/E ratio simply refers to the multiple of profits. Established businesses with a long track record of profits can use this approach. This is also a good method where the business has recently signed up to long term contracts which would generate higher turnover and profits over the coming years. How P/E ratio is determined can vary drastically depending on the industry and the age of the business. More established businesses have lower P/E ratios while tech start-ups often have a higher P/E ratio.
A Business using this approach would look for industry and age comparable P/E ratio and apply this to the business profits after taxes. As an example, a business after researching similar companies that establishes a P/E ratio of 5 that makes a profit of £ 100,000 post tax would be valued at £ 500,000 pre-money.
Entry Cost
A simple yet time consuming approach to valuing the business. This approach would factor in everything that it would cost you to set up and get the business to where it is now. This includes buying all the assets, material, building the customers, recruiting staff, time cost and goodwill. The main difference between this and the asset approach is that this takes account the current market value of everything rather than its book value. This approach is used where you have a lot of entry barriers.
Discounted Cashflow / Profits
This is the most complex method of valuing a business. Unlike other approaches you would need to build up a cashflow forecast for the next 10 to 20 years and discount the value of them by the expected return or cost of capital. This can be simplified by only discounting the expected dividends instead of a full cashflow. This method is used for mature and larger companies with a steady cashflow/profit. This method is frequently used on companies such as utility companies, property companies receiving ground rents and purchasing ground rent freeholds.
Industry standards
This approach is based on an externally driven perceived value instead of a calculated value. Certain industries have certain standards and rules that are used as guides. This can be a multiply of the turnover, fixed assets, stocks, or number of outlets for retail businesses.
Based in Brand value and other intangible assets
Some businesses are valued far above or below all the above methods. In essence, a business’ actual value is what someone is perceived to be worth and willing to pay. This takes into account all intangible assets, value of time, negotiation skills and strength of the team.
Valuation based on an offer in hand
Sometimes the value of a business can be a completely arbitrary value determined by an amount someone was willing to pay for the business. This could be determined by a premium the buyer is willing to pay to own the business. Like they say, the value for one might not be the value for another!
Valuing a business can be daunting and time consuming. Making sure you get this right is key to getting optimum results from the valuation. Businesses that are not valued correctly end up not raising sufficient funds or end up in a failed fund raise. It can also result in the owner not understanding the stage of the business and making long term decisions that can lead to serious consequences. It’s important to understand and plan ahead, take into account all factors and processes in place to build good value and confidence in the business.
If you are looking to value your business or prepare for an investor pitch, get in touch with us today. Our team of experienced accountants will assist you step by step in taking you through all aspects of getting the value right and optimising the purpose of the valuation. Get in touch with us today on 0208 249 6007 or [email protected].
Written by Quraish Adamally.