Thinking of selling your business? Time to get it valued

There are several factors you need to consider when valuing your business and there is no exact science to carrying out a valuation. Some of the factors you need to consider include but are not limited to:

  • Establishing what are the reasons for selling the business.Â
  • The condition of the market and the industry.Â
  • The business name, brand, reputation, trade marks, goodwill and designs.
  • Any intellectual property rights owned by the business.
  • The value of any machinery and equipment owned by the seller.
  • The financial condition of the business. The importance of the employees to the business and the skills they offer.
  • The markets the business operates in and the location of the business.Â
  • The value of any assets owned by the business.
  • SWOT – the strength, weaknesses, opportunities and threats of the business.Â
  • Customer value and the value of any contracts and orders.Â
  • The tax ramifications for the buyer and seller.

There also differing valuation methods such as:

  1. Industry Rule of Thumb
    • This is a valuation method that has been established for a specific industry.
    • The amount of profit a company makes is not the only factor this valuation method considers and buyers will usually pay what it is worth to them.
    • Take for example a purchaser may be concerned with the number of franchise outlets for a restaurant business or the number of subscribers to an online business rather than just the profits of a business.
  2. Discounted Cash flow
    • This method calculates the value of a business by adding the forecasted dividends of at least the next 15 years plus a residual value at the end of the term.
    • The future dividends calculation is based on a discounted interest rate which takes account of the value of money now, in the future and the risk. Take for example £1 today, the value of this £1 will not be the same as you receiving £1 tomorrow.
    • This method for valuing a business is very technical and is usually used for established, cash generating business with strong long term prospects.
  3. Price/Earnings
    • The price/earnings ratio is calculated by dividing the value of the business by its profits after tax.
    • Price/earnings ratios are used to value a range of businesses and are very widely used.
    • When calculating the price/earnings ratios quoted companies tend to have a higher ratio as their shares can be bought and sold far more easily than non-quoted companies. Typical price/earnings ratios for a large quoted company can be in the region on 20.
    • Other factors to consider when establishing the price/earnings ratio include price/earnings ratio competitors have used, higher growth forecasts, companies consistently in profit, etc.
  4. Entry Cost
    • The purpose of an entry cost valuation is to establish if it would be more cost effective to start a new business from scratch rather than buy a business.
    • This type of valuation allows for the buyer to consider cheaper alternatives to buying a business by taking into account the cost of raising the finance, buying the assets for the business, developing the products, building on a client base, using better technology or finding an inexpensive location.
  5. Asset Valuation
    • This type of valuation typically applies to well established and rich asset businesses.
    • The valuation is calculated by adding up all the assets and subtracting the liabilities.
    • Typical businesses which use this type of business include property or manufacturing businesses.
    • The first step involves establishing the business assets and establishing the value stated in the accounts (“Net Book Value – NBV”).
    • The NBV figure is then refined taking into account any change in circumstances with regards to the assets e.g. updating valuations, old stock, debts not which are never going to be paid, etc.
    • The NBV figure should also take into account any future factors such as the cost of closing down premises, any costs involved in relocation, redundancy payments, debts becoming more difficult to collect, etc.
    • Once the NBV figure has been finalised the liabilities can then be taken away and the asset value can be established.

Both the buyer and seller are likely to consider these factors and valuation methods when valuing a company, focusing on the strengths and weaknesses of the business. The sale price is usually a negotiated compromise, but the valuation methods can help in focusing the minds of the buyer and seller to reach an agreement.

If you are considering selling or buying a business and require any further information please feel free to contact Izaz Ali on izaz.ali@lawdit.co.uk.

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