How to Value My Business
Thinking of selling your business or looking for investors?
But how much is it worth?
That’s a tough question.
In my experience sellers tend to over value whilst buyers will have a tendency to under value.
That’s completely natural – think of buying or selling a house or a car – there’s always a degree of horse trading involved.
But whereas with a house or a car there is an active market for them & generally there are a set of criteria to help us get to a base price to begin the haggling, i.e. age, model, condition (car) or location, number of bedrooms, style (house).
So where do we start?
I’ve heard it said that there are hundreds of ways to value a business, but surely that leaves too much room for interpretation.
So let’s condense it down to the main ones that can be understood (without needing a Degree from Harvard Business School).
#1 – Net Asset Value
Net Asset Value (also referred to as Book Value) is calculated by deducting total liabilities from total assets.
It’s an effective way to test the valuation of a business with significant assets such as property, inventory, receivables and equipment.
For small businesses, this method may not be enough to give a complete picture unless significant assets are involved.
It can also be used to value companies that are sitting on significant assets but generating very low profits and slow growth.
For example, businesses such as manufacturing, warehousing, distribution, datacentres, etc. generally use book value for valuation as it more accurately reflects their situation because these types of business require heavy start up costs to begin operation.
#2 – Discounted Cash Flow (DCF)
The DCF valuation method is used to estimate the value of an investment by calculating its future cash flows.
A DCF analysis uses a discount rate to determine the present value of the expected future cash flows. The potential investment is checked against a present value estimate and if its cost is less than the DCF value, the investment is considered.
Now for those of you with an advanced qualification in Economics you’ll recognise this formula:
DCF = [CF/(1+r)^1] + [CF/(1+r)^2] + [CF/(1+r)^3] + … + [CF/(1+r)^n]
For everyone else, here are the variables:
CF is Cash Flow in the period
r is the interest rate or discount rate
n is the period number
For those of you at the back who didn’t understand any of that, the DCF value represents the amount an investor would be willing to put into an investment given a required Return on Investment (ROI).
You can use it to value an entire business, a project within a business, shares, a bond, property and anything that affects cash flow.
#3 Multiple of Earnings
The essential point here is that a business is valued based on a multiple of it’s current or historic profitability.
In this case we are interested in Earnings Before Interest & Taxation (EBIT). Also it is sometimes referred to as Earnings Before Interest & Taxation, Depreciation & Amortization (EBITDA).
But let’s not split hairs here – we’re talking about how much is left in the pot at the end of the year before you pay the taxman.
In its simplest form it is Total revenues less Cost of Goods Sold less Operating Expenses.
This figure appears in your Annual Accounts.
A potential buyer is likely to look at the historic profitability of the business over a 3 or 4 year period and take an average to ensure that they smooth out the ups & downs.
Once you’ve got your EBIT figure you can start to calculate the value of your business using a multiple of this figure.
And this is where the fun starts.
Why? Well because the multiple is not an exact science.
Think about it. If someone is using a multiple of EBIT (i.e. annual profit) to calculate the value of a private business they wish to buy then you need to be realistic about valuing it.
Because essentially that person is asking themselves the question “How long will it take before I get a return on my investment?”.
So if you’re a small private business that has no tangible assets (Buildings, Machinery, etc.) with say £100K of annual profit (i.e. EBIT) & you are trying to sell your business for £1M that would be a multiple of 10 (i.e. 10 x £100K EBIT = £1M asking price).
So ask yourself whether you would be prepared to invest £1M of your own cash with the likelihood of only turning in a profit after 10 years.
Hmm, not very likely I’m sure.
They might be prepared to wait a year or two (or three) & they might see ways to improve profitability so that will affect their decision too.
Now I hear you saying “But I’ve seen companies in the same sector as me on the stock market selling for x10 or x20 multiples”.
Sure, but these are usually huge companies with vast assets & millions of customers. Also, bear in mind that buying & selling small, private businesses can be risky. They take time to buy & they take time to sell.
With public companies on the stock market an investor can buy in the morning & sell in the afternoon – they are much more Liquid than small businesses so that has a huge effect on their multiple.
Beyond Numbers: Factors That Affect Business Value
Other factors might affects the value of the business negatively or positively during valuation. They include:
– Type of business.
– Business interests of the company.
– Availability of data for analysis.
– Economic status.
– Physical location.
– Competing companies.
– Non-compete clauses.
– Proprietary information.
– Vertical market and industry performance.
– Stage of growth.
– Management team.
There are a number of different ways of valuing a business.
But you need to be pragmatic. It would be nice if there were loads of Richard Branson’s walking around with pockets stuffed full of cash just waiting to buy your company.
But the reality is that Buyers will need to base their investment on the cold hard numbers in your business.
Using Asset Valuation is good for Asset heavy businesses.
Cashflow focuses on the future earning potential whereas Multiple of Earnings looks at the historic profitability of the business as a guide to future performance.
None of these is perfect & remember that ultimately it all boils down to being able to find an agreement on the price. If you can find something that works for both parties, great.
If you can’t find something that works then you both need to be prepared to move on.
Business Valuation FAQs
- What are the Main Business Valuation Methods?
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- Business Valuation Template