Firstly, why should you value your business?
There are many reasons why you should consider valuing your business. The most obvious is if you are selling, or if you are splitting from a business partner and need to know the value to buy them out.
Valuing a business can be important to not only understand a businesses’ potential value but can also be an effective business leading indicator and management tool. Particularly for those companies which are preparing to sell, an indicator aimed at building value is particularly useful in driving additional money on sale.
Want to value your business now? Why not try our business valuation calculator today.
Another huge advantage to knowing what value your business has is to secure funding from investors. Not only will potential investors want to see a full valuation report, but employees looking to buy shares in the company will also need to know how much the business is worth.
Other reasons can also include:
- Being able to sell a business quickly
- Negotiating better terms
- Choosing a good time to sell a business
- To actually improve its value
- Identifying areas for improvement
- To gain a better knowledge of company assets
Whatever the reason, you should consult a professional valuer, such as a business broker, to help. In this blog, we will explore the approaches business brokers take, as well as answering some frequently asked questions.
What information do you need to value your business?
For the most part, the trading accounts of the business are essential to derive the value of any business. A buyer is going to look at the profitability of the business first. They are then likely to assess the balance sheet for value, usually against which they might secure funding.
Assessing the operation of a business may also be a key source of information for a buyer, together with details on staff skills and ability. What exact information is required to value a business will be sector-specific but for the most part, three years profit and loss and balance sheet will be required together with any projections for the future if available.
How do I calculate the value of my business?
There is a phrase in the business world: ‘a business is only ever worth what someone is willing to pay for it’ – and this is absolutely true. If there isn’t a buyer out there willing to pay the price of the business in question, then it simply isn’t worth what you’re asking for it.
That said, if the valuation is for a loan or security purposes, the question of whether a buyer is out there who is willing to pay a particular price can only be determined from historic transactions for similar businesses. This is called comparable evidence. Remember, the valuation is only ever a starting point for negotiations to commence.
It is essential that you know from the beginning what your exit strategy is going to be. If you want to sell the business eventually, then build it with selling in mind, regularly assessing its strength and growth by its sale price. This is essential to achieving maximum potential when selling.
There are a number of ways to value your business, depending on the buyer and the industry norms. For the purpose of generality and application to a broad spectrum of business types, we will focus on two areas of valuation which business brokers use: EBITDA Multiple and Asset Value.
Two methods to value your business:
Value your business with the Multiple Method
The valuation multiple method is one of the most common used to value your business, also called the Multiples Approach or Multiple Analysis, determines market values for similar companies which can then be used as ratios to compare your own company to. If similar assets in comparable companies sell at similar prices to yours, a relatively accurate comparison can be made. A multiple in this sense, is a ratio calculated by dividing the market value of an asset by a specific item from a company’s financial statements.
There are two main ratios used in this method. Equity multiples include price/earnings ratio (P/E) and price/book ratio (P/B). Enterprise value multiples are more commonly used in this method however, as they are more comprehensive than others and focus more on key statistics. These multiples include Enterprise Value to Sales ratio (EV/sales), EV/Earnings before Interest and Tax (EV/EBIT) and EV/Earnings before Interest and Tax, Depreciation and Amortization (EV/EBITDA).
Value your business using EV/EBITDA
Earnings Before Interest Tax Depreciation and Amortisation (EBITDA) works with the businesses operating profit or net profit before any tax or interest charges are deducted.
Depreciation and amortisation are accounting principles that allow the writing off of tangible and intangible business assets on the balance sheet. The assets are broken down to represent an annual cost of the particular asset based on its perceived operating life.
For example, a company van that is bought for £25,000 and perceived to last 5 years will be charged to the balance sheet at £5,000 per year. It is worth noting that one-off and exceptional costs should always be added back into EBITDA too.
An EBITDA multiple is exactly what it says; taking the EBITDA and multiplying it to get an accurate valuation figure. It is possible to see a wide range of multiples used in business valuation, but for the majority of small, owner-operated businesses, you would be looking to achieve between one and three times EBITDA.
A good business broker can share actual sale prices and multiples with you which means you know the price you are asking is a good starting point.
Valuation Multiples Process
In basic terms, the valuation multiples method proceeds as follows:
- Identify similar companies who have the same assets as your company.
- Find a comparable market value for each company.
- Create ratios (valuation multiples) through standardization, typically using EV/EBITDA.
- The valuation multiple is then applied to your chosen key statistic which allows for the variation between your company’s chosen, comparable assets.
Pro’s and Con’s of using a Multiples method to value your business.
- Allows fast calculations when needing to assess company value.
- Relatively easy to use and calculate.
- More choice in regards to what you believe are useful values i.e. it would be your choice whether to remove outliers to enable less skewed averages.
- Can simplify complex information that disregards intrinsic values.
- Heavily reliant on having correct market values rather than fair values.
- The chosen ‘similar’ companies may have differing business and accounting practices that alter the values as it is not a true, comparable company when compared to yours.
Value your business using the Asset Value approach.
Where the assets of the business are worth more than the EBITDA multiplied sum above, it would be unrealistic to use the multiple valuation method. Instead, the value is in the assets, so you would want to sell them for their current value.
If you are a limited company, there are certain things required to prepare for sale, such as reconstituting your balance sheet to bring the actual value of fixed assets up to date to reflect the market value, rather than the artificial depreciated value that your accountant may hold.
If you are a sole trader or partnership, you will simply need to make sure you know the value of your assets and ensure they are free from any encumbrance, namely finance agreements or other restrictions.
In reality, a sole trader or partnership could value the assets themselves by looking online to get valuations of similar assets. You may achieve a small premium for the fact the business is in situ and trading so again, seeking advice is key to achieving the best value.
Can you value your business on turnover?
There are many suggestions on the internet and indeed searched questions around valuing a business on turnover. Whilst there are some sectors and industries that value your business based on turnover, it is not appropriate for the vast majority.
Even though you can arguably obtain a rough idea as to the value of the business using the turnover, it will never be entirely accurate. Such methods make too many assumptions as to the cost base of businesses and so can never be wholly relied upon. It can, if a business fits within an expected cost profile, provide an indication.
Which factors affect business valuation?
There are many factors that have the potential to affect a business’s value. For example, the location can prove integral or detrimental to a company’s success. In addition, whether your business trades online, or from freehold or leasehold premises.
Great customer access and a well-designed premise can easily increase your business valuation. Whereas, poor location and access could result in you receiving a lower valuation.
Industry growth is another factor that may affect your business valuation. Companies that are in rapidly growing industries are much more valuable as a whole due to market demands.
Along with industry growth, a business’s earnings growth can determine how valuable they are. If your business has an impressive earnings growth track record then expect your valuation to be higher.
The other common factors that can apply to most businesses are profitability, market advantage, established processes and procedures, intellectual property, access to key customers, reputation, market share, competitive environment, and customer concentration.
What is a P/E ratio?
A P/E ratio is the profit to earnings ratio and is a method that can be used to value a small business. In other words, at what rate is an investment repaid through earnings. For example, if you buy a business for £100,000 and it returns £25,000 a year profit, the P/E ratio is 4.
How to value your business quickly
In order to get an accurate, reliable business valuation, it is crucial to work with an experienced valuer. Hilton Smythe can value your business quickly.
An unrealistic business valuation can deter away potential investors and frankly, leave you looking unprofessional. Or even worse, you could sell it for much less than it’s actually worth!