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You will have heard the old analogy of your business being what someone is willing to pay, which can be true for some elements of the business but there are obviously more fundamental ways that a business can be valued.
For the larger percentage of business owners this will be the first time you will have sold a business so this may be a new area.
Professional advisers will be able to guide on a valuation, but we always feel as business owners you should at least have some grasp on this yourself.
As we begin this exploration into valuing a business it is useful to first give thought to some of the factors which will impact the valuation of a business. It is worth thinking about these and whether you feel these would impact positively or negatively on the potential sale of your business or the price you receive as part of that sale:
These factors will include the following. These are in order of what we feel will have most impact:
- the circumstances surrounding the valuation (e.g. a forced sale rather than a voluntary one)
- the strength of the team behind the business and if there is sufficient management structure in place for the business to operate without the owner’s input
- the business’s reputation
- the business’s trademarks/patents, if applicable
- the value of the business’s customers and the relationship you have with them
- the age of the business (think start-ups making a loss that have lots of future potential, versus established profit-making companies)
- what kind of product, if any, you have
There are various valuation methods which may be relevant to your business, at least in part. We describe these below:
Earnings Multiplier (Price/Earnings Ratio).
One of the simpler and more common methods for valuing a business is where your earnings can be multiplied by a factor to give you an approximate valuation.
The formula looks like this: Value = Earnings after tax × P/E ratio
Once you have the appropriate P/E ratio to use, you multiply the business’s most recent profits after tax by this figure. For example, using a P/E ratio of 5 for a business with post-tax profits of £100,000 gives a business valuation of £500,000.
The trick when it comes to P/E ratios is that no single figure can be used for any one business. The factor relevant will depend on the type of business you run.
Some industries have ‘standard’ P/E ratios for valuing a business, and others can vary greatly. We have detailed information on appropriate P/E for all business sectors so please get in touch when you need help with your business valuation.
Also try contacting your industry association or Chamber of Commerce for their advice on determining the most appropriate P/E ratio. Another possible source of guidance is the financial section in newspapers that gives historic P/E ratios for listed companies.
Entry Cost
Rather than buy a business anyone could go about setting on up on their own. The cost of doing so provides the Entry Cost valuation figure.
This can include costs such as:
- Purchasing or financing its assets.
- Developing products or services.
- Recruiting and training the employees.
- Building up a customer base.
This allows you to then make a comparative assessment against the sale of your business.
Here is a quick and simple example:
- Cost £400,000 to buy the set-up equipment.
- Cost £50,000 a month for overheads.
- Require 12 months’ trading to get a customer base.
A business that already has all of the above is worth at least £1m (£400,000 for equipment, and £600,000 overheads for 12 months).
Having this figure then allows 2 things:
- As a business owner this is good evidence for a conversation with a potential purchaser of your business, as support for a particular sale price that is being discussed. A sale price below this figure is obviously giving a potential purchaser an immediate benefit
- We always suggest that any business seller goes through this process, as this gives a good reality check and also then may help guide a valuation based on another method (e.g. The Earnings Multiplier method)
Valuing the assets of the business.
For any business with significant assets a route to a sale may involve a purchaser buying just the assets of the business.
The starting point for an asset valuation, on this basis, is the assets listed in the financial accounts of the business. This is known as the ‘net book value’ (NBV) of the business.
You should then think about the economic reality surrounding the assets. Essentially, this means adjusting the figures according to what the assets are actually worth.
For instance, old stock depreciates in value or may need to be sold at a discount.
If there are debts that aren’t likely to be paid, knock those off.
Property could have changed in value needs to be refined too.
Intangible items, for example, software development costs are excluded.
This final figure will give you the asset valuation of the business.
Other factors – A valuation based on what you can’t measure
This brings us to the most challenging element of valuing a business which are the factors that can’t be easily measure and the question of how you put a value on those. This can be challenging, and most businesses will most likely have a portion of this.
Examples include:
- Intellectual Property
- Management stability
- Business Relationships
Goodwill – This can include the value of a company’s brand name, solid customer base, good customer relations, good employee relations. The perceived value attributable to goodwill will likely result in a seller seeking a sale price in excess of the valuation provided via the other valuation methods.
Some examples:
Business Relationships: If a business holds a licence or distributorship rights across the UK for a product expected to be successful, the business’s value will increase accordingly.
Management stability: A business will be worth far less if key members of the management team are leaving as part of the sale.
For example, the profitability of an advertising agency may collapse if a key creative person leaves. Similarly, if key salespeople leave, they may take important customers with them. Any written agreements or incentives to retain key employees could add value.
Intellectual property: If you’re selling a patented invention, you can value your business higher than a similar business selling an unprotected product.
At RCP we have become very good at valuing businesses so can advise on the best approach for your sale.
For any business we are seeking to purchase we always seek to be open and transparent about the valuation methodology we have chosen and how an offer price corresponds to this.
Please get it touch to find out more.
