How much is your business worth?
Adam Stronach summarises three main methods for valuing a business
Whether you’re making exit plans or in discussions with investors, having details on the value of your business is a vital step.
From the inside, it might be hard to say what that value is. You’ve put long hours of hard work into building your business from the ground up, but how would a buyer or investor see your business in monetary terms?
As a starting point, it’s important to work out what it is you’re actually selling.
Are you selling the trade and assets? Is it the shares in the business you are looking to dispose of? Is there intellectual property in the business? Does it own property or does it lease premises?
The kind of business you run, the sector it’s in, the assets it holds and the people who work with you could all have an impact on its overall value.
Assessing all of this information at the outset will help you to come to a robust valuation for discussions with potential buyers.
Benefits of valuing a business
We’ve already mentioned a couple of the main reasons you might want to value a business – as part of your exit strategy, or to help you raise investment.
When it comes to selling your business, the process for valuing it can also give insight on the right time to sell, the best possible deal, or how to move negotiations along quickly.
It can also be useful to know when you’re planning your retirement, and thinking about your financial future and that of your family.
Research by Which? suggests most households spend around £27,000 a year in retirement, but to fund a more luxurious lifestyle – including long-haul trips and a new car every five years – you’ll need something closer to £42,000 a year.
Depending on your financial and lifestyle goals, you might want to find out whether selling your business could help support that level of income throughout your retirement.
Alternatively, valuing a business can help you and your team to focus on areas for improvement and grow your business. You may choose to conduct an annual valuation to give you timely staging posts on the position your business has reached.
And if you’re offering employees the option to buy or sell shares in your company, it can help you to set an appropriate price. Crucially important here is to ensure the price is something HMRC will accept, including if tax-approved schemes are being used.
Things to consider
There are several factors that might come into play when determining your business’s value, and some of these are included in the valuation methods summarised below.
Structure: Can the business function effectively without you? If you find it needs your constant attention to remain profitable, you may need to look at ways of streamlining, automating or delegating work.
Circumstances: If you’re under pressure to sell quickly – for instance, because you need to pay off creditors or you want to retire due to ill-health – the price may be lower than if you have time to achieve a better deal.
Financial record: Detailed, accurate records that show a sustained history of strong financial performance will work in your favour when your business is being valued.
Reputation and customers: Is your business well known within your field, and do people have a positive impression of the quality of your product or service? Do you have a solid base of returning customers who trust your brand, not just a handful that you rely upon? How robust is your customer base?
Staff: The skills and experience of your staff can often be a major strength in your business. A loyal team of people who work well together will be reflected in the value but remember to consider how much of the business depends on your leadership.
Intellectual property: What’s the value of any licences or similar assets that your business owns? Do you have software, for example, or innovative designs for your products?
Product or service: A high-quality product or service can mean a higher-value business. This may be reflected in the margin your product is earning, and how it compares to others who may operate on higher volumes.
Age of the business: Businesses in their early stages may have a lot of potential but they’ll often make losses. More established businesses tend to be profit-making and face fewer risks.
Business valuation methods
Once you’ve gathered together all of the relevant information about your business, it’s time to get into the technical details of assessing its value. Three main methods for this are set out below.
The most appropriate valuation method for you will depend largely on the type of business you operate: the sector it’s in, the size of the business, how long it’s been running, and so on.
Most people will use a combination of methods to reach a final assessment of value.
1. Valuing assets
This method looks at the value of the assets owned by your business, takes away any liabilities, and bases the overall value on that figure. This makes the most sense if you have an investment or property business, with valuable assets generating the returns the business enjoys.
Intangible assets, including the goodwill your workforce helps to build, or intellectual property like licences tend to be much harder to value. Businesses that rely more on these assets than tangible ones will generally need to consider an alternative method.
2. Discounted cashflow
The discounted cashflow method uses future forecasts over time to assess what a business’s future cashflow might be worth today. The business’s value is worked out at a discounted rate to take into account potential risks and the decreasing value of money over time.
This method is one of the most involved ways to value a business and it relies on many assumptions about conditions in the medium- to long-term. It is often used for businesses that are changing in nature, or young, growing businesses. But it does rely on accurate and reliable forecasting of the cash the business may be able to generate.
3. Multiples approach
Also referred to as the ‘capitalised earnings approach’, this method uses a ratio or multiple based on market metrics for other similar businesses. This tends to suit more established, larger businesses that have had stable growth and sustained periods of positive earnings.
A ‘multiple’ is usually a ratio that’s applied to maintainable earnings and is then subject to further adjustments. This approach is often used by buyers or investors who want to assess an offer price for a company.
If you would like to discuss how you go about valuing your business, contact Adam Stronach.
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