There is no easy way or set formula for valuing your business and there are several models that have been developed to make this process easier. But before we discuss the various methods involved we need to be clear on why you are valuing your business, as the process can become costly. Below is a non-exhaustive list of reasons why you may want to have your business valued.
- Buying and Selling a Business
- Prior to the purchase of sale of the business we would always recommend getting a valuation of the business done, to help the negotiations, complete a purchase more quickly, to help identify the real value of the business and to identify whether it is a good time to sell.
- Raise money and create a market for the business shares
- Focus and motivate management and employees
- Provides an incentive for staff performance and highlights the areas of the business that needs improving.
Having decided to value your business you must be aware that there are several different ways to value a business and that any forced sale or winding up of the business will affect its value.Â Other factors which need to be considered when valuing the business include the number of tangible assets it owns and how long the business has been trading.Â The most difficult stage of a business is usually when you are starting and many businesses make a loss in its first few years of trading. However, the future profitability of the business or the development of a new technology may result in the value of the business being considerably higher.
The methods of valuing a business include:
- 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.
- 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 Â£1 today, the value of this Â£1 will not be the same as you receiving Â£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.
- 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.Â
- 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.
- 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 (ÂNet Book Value Â NBVÂ).
- The NBV figure is then refines 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.
There is no definitive answer to what your business is worth and it usually comes down to what the buyer is willing to pay. However, we would always advise that you consider at least two of the valuation methods mentioned above prior to buying or selling a business, we would not want you to sell your business for less than what it is worth or a buyer paying over the odds.Â
Lawdit have been buying and selling businesses for over 12 years, working with its clients to ensure the deal completes and the client is fully protected. If you would like any further information to buying or selling a business please do not hesitate to contact Izaz Ali on firstname.lastname@example.org .