The decision to sell your business can often be a difficult one to make – most business owners have put a significant amount of time and energy into building their business. For many owners their ultimate strategy is to build a business, maximise it’s value and then ultimately sell up, either to move onto something else or retire.
The most common mistake is that business owners, because of their emotional connection to the business, means they overvalue it. But it’s important to get an objective and accurate valuation and not one that contains all the emotions you feel about your company.
So, if you’re thinking of selling up or just simply want to understand what your business is worth, here’s how to value your business.
Why value a business?
The reasons for valuing a business can be varied. It could be for tax purposes, a shareholder dispute, a divorce, or because an owner is looking to sell up. But the need for an independent and accurate business valuation is critical.
There are many benefits of understanding the value of your business – here’s just some of them:
- It can give you a clear overview of the financial health of your business and help you to pinpoint underperforming areas or parts of the business you need to focus on to improve.
- It helps to put some form of ‘price tag’ on your business, which is useful if you’re selling your business, planning your exit or may get unexpected offers or approaches to buy your business.
- If you’re looking to secure funding, it can help investors get an estimated value of the business in which they are potentially investing.
- If you’re considering selling shares in the business, valuing your business can help to set a fair share price.
There are several ways that a business valuation can be worked out. These are below.
If your business has large or valuable assets, then this could be the best approach.
This method considerstangible and intangible assets. Tangible assets are the physical things belonging to your business, such as your premises, stock, and equipment. Intangible assets are any non-physical assets, such as your business’ intellectual property like it’s brand, patents, and copyrights etc.
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.
This method often produces a lower value as it doesn’t consider ‘goodwill’ towards a business. You should consider the market value (what someone is willing to pay) and the value of it’s net assets (assets minus liabilities).
The price earnings ratio
A common approach used in many sectors is uses earning multiples – a formula based on a multiple of net profits (the Price/Earnings (P/E) ratio representing the value of the business divided by its post-tax profits).
Accountants and corporate finance firms can advise on the multiple for your sector. If the multiple is, for example, five times net profit, then the business value calculation is simple.
However. while multiples of earnings can be used as a business valuation method, there is no standard P/E ratio figure that can be used to value every business.
The P/E ratio will be affected by the sector your business is in (for example IT / Technology business will command higher ratios than a retail shop). But the P/E ratio can also be affected by the perceived risk in your business i.e. an over reliance on the owner or main product or main customer. This over reliance will undoubtedly mean a lower P/E ratio and lower value.
Discounted cash flow
The discounted cash flow method can be one of the more difficult ways of valuing a business. This method focuses on what out what a future stream of cash flow is worth today. This method is better suited to businesses with stable projected cash flows for the future.
Entry cost valuation
This method values a business by referencing to the cost of starting up a similar business from scratch. This asks the question ‘if my business didn’t exist, how much money would it cost to start it from scratch, now?’
To use this method you need to work out a detailed list of start-up costs, the price of acquiring assets, employing staff, establishing a customer base, and developing your products or services. You can then look at how you save on these set up costs and this would give you an estimated entry cost valuation.
This method involves looking at businesses like yours and assessing their value. You can do this by looking at similar businesses recently sold or those where the value is in the public domain. It’s broadly based on what similar companies are worth at present.
Increasing the value of your business
To get more money for your business or a higher multiple you should consider the following:
- Reduce the businesses’ reliance on you as the owner.
- Reduce the businesses’ reliance on key customers or key suppliers.
- Create unique systems or products that differentiate your business.
- Create new products to bring to market.
- Create new distribution channels to get your product to market.
- Create a strong brand.
- Create a business that’s scalable.
- Iron out financial irregularities and get your finances in order.
However, despite these various methods of valuation, the value of a business can simply come down to what the buyer is willing to pay for it at that point in time. If your company ticks all the buyers boxes, then they may be willing to pay more. If another company like yours is unlikely to come up for sale again soon, then a buyer may pay more.
Business valuations are as much an art form as they are a science. Working with an advisor who has a solid understanding of your business, your market, and a breadth of knowledge in valuing businesses is key.
If you want more help with valuing your business, then contact us.
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