Thinking of valuing your business?
Valuing a business is an important task regardless of where you are in your business venture. You may want to sell your business or map out its future development. Getting a valuation has a lot of benefits, but it can be a challenging process. You will need to decide on appropriate methods that suit your business so you can secure the best buyer and receive a financial reward for all your investment in the business.
This step-by-step guide will help you prepare for the valuation process by offering reasons, methods, a few sector-specific valuation examples and professional support.
If you need to value a business quickly, we'll let you know what techniques you can use to get a swift outcome. You may want to take your time and get a more detailed valuation, so we'll cover ways you can achieve this too. Reading through this guide will help you manage your expectations on valuing both small and large businesses.
What is a business valuation and why should you consider it?
In essence, the purpose of a business valuation is to paint an accurate picture of your business's worth. Valuations consider some combination of the market value of assets, current and/or projected revenues and/or cash flow and other barometers of your business's health. Getting an accurate valuation will give you granular insights into its functionality and financial value.
Possible reasons for valuing a business:
- You want to know your business's value before selling it
- You want to gain a better understanding of your business so you can have practical expectations for the selling or buying process
- You want to find where the strengths and weaknesses lie
- You want to identify areas that need improvement
- You want to determine if its success is sustainable
Benefits of valuing a business
- Setting a credible asking price before selling the business
- Providing information that reassures buyers and reveals ways they can build further value
- To inform an exit strategy for growing, improving and eventually selling the business
- Securing capital investment from investors
- Setting the price of shares for purchase by employees
Criteria that affect a business valuation
There will be different criteria that affect the value of a business, and they will vary in importance. These can range from your fair market value of tangible assets and your historical financial performance. Here are some basic factors you will need to consider when valuing your business:
- The circumstance of the valuation: this may be a voluntary or forced sale. This can impact the valuation and power dynamic during negotiations
- The value of your tangible assets: this can include cash, premises, land, machinery, furniture, stock, equipment and employees
- The value of your intangible assets: valuations can account for historic and projected profits, revenues and cashflow. Projections are estimated based on your intangible assets such as the business's age, goodwill, intellectual property, and the business's core values and culture
- The durability of these assets and wider economic conditions or external influences. For example, a gloomy economic outlook would not undermine the appeal of a recession-resilient business like a pawnbroker or convenience store. And a business whose revenues have been growing steadily over many years will offer the stability that is much prized by buyers.
Thinking about these areas will be advantageous as they illustrate where your business is and how it can improve. It will also give potential buyers a comprehensive outline of your business's value so that they can manage the risk profile of your business.
Keep in mind that for some companies, high growth means that the value changes rapidly. If your business has grown significantly since you started it, you may be looking to bring in a partner. If this is the case, make sure you know what your equity and share value is. Whether you are searching for potential buyers or developing your business, considering these areas will give you an accurate picture of your business's worth.
Business Valuation Techniques
Naturally, how you value a small business (like a café) would differ from how you value Amazon, Apple or Accenture. Most business valuations consider the value of physical assets and income and often draw on multiple valuation techniques. We briefly cover these in our selling guide, but we will discuss them in more depth here.
The Asset Approach
This approach is effective for businesses that are asset-rich, like a property investment firm or manufacturers. Used alone, it is also useful for businesses in liquidation. The asset valuation method establishes the ‘net book value' (NBV) – or net asset value – by subtracting the total value of liabilities from the total value of business assets recorded on the balance sheet.
The resulting figure is then adjusted for factors such as changes in asset values, bad debt and ageing stock that must be sold at a discount. Keep in mind though; this approach does not consider future earnings or goodwill.
Seller's Discretionary Earnings
If you have a small or middle-market business, this method would be suitable. The SDE method considers your total cash flow including discretionary items like salaries, benefits, and depreciation. Remember to include your expenses in this method, like your rent and labor.
This method gives you a strong reflection of your business's profit potential by calculating what the business's earning would be with the buyer.
Price-to-Earnings Ratio (P/E ratio)and EBITDA
The price-to-earnings (or P/E) ratio method establishes the value of a company's earnings per share. Used to determine whether a limited company's stock price is overvalued or undervalued, it usually only applies to companies listed on the stock market.
Determining the most accurate number for your P/E ratio depends on your type of business. It is a good idea to compare your business's P/E ratio with others to find their relative value.
The acronym EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation. A company valuation based on EBITDA will look at the net earnings before any other facts are considered. Remember that this method ignores many factors that could impact the profitability of your business.
Entry Cost Evaluation
Entry cost valuation predicts what it might cost, approximately, to establish the business from scratch, including the cost of fitting out premises, employing and training staff, developing products and services, and establishing a customer base and reputation.
The hypothetical business must be built as cost-effectively as possible, for instance by locating premises in a less expensive area if this wouldn't credibly weaken profitability.
Discounted Cash Flow
The discounted cash flow method calculates the present value of projected cash flows. A discount interest rate – typically around 15%-25% – is applied to account for the ‘time value of money', whereby cash becomes more valuable over time due to its income-generating potential.
Based on long-term assumptions, this income-based approach is typically used by the largest companies with long, consistent trading histories such as banks, utilities and energy companies.
This relatively basic method calculates a figure based on valuations of similar businesses – in terms such as size, sector and location – that are available in the public domain.
How can I secure a realistic valuation?
You can maximize your business valuation and eventual sale price by improving the business beforehand. You can do this by using appropriate valuation techniques and being strategic about how you market your business and negotiate a deal.
Valuing your business is not only about its net worth. While this is an important factor, long-term strategic planning is vital. Make sure that your business plan considers details like your present and future goals, what improvements you would like to make and any other information you think a potential buyer would want to know. This will illustrate your business's potential.
Negotiation skills - confidence is key
Getting an accurate valuation will arm you with useful knowledge when it is time to negotiate the sale of your business. Understanding the details of your business's intrinsic worth will boost confidence in your negotiation skills, which will likely lead to a better sale.
Demonstrate to potential investors and buyers that the assumptions underpinning your valuation are realistic. It will help to convince them that the business is worth investing in, and that they have the skillset and experience required to generate a solid return on their investment and perhaps take the business to new heights.
Seek professional advice
The valuation process can be challenging, so seeking professional advice will be helpful. If you take this route, make sure that the person you enlist has appropriate knowledge and expertise of businesses like yours. This will include your business's size and sector.
An accurate, fair market value of your business is important, so make sure you or anyone helping you considers the size and sector of your business, and the type of product or service you offer. These factors will affect how your business is valued.
While there are similarities that run through all valuation processes, each sector will have different circumstances. To illustrate the valuation process in practice, we offer some examples of different sectors below.
How to value a petrol station
Petrol station values are typically appraised using one of three valuation methods.
The income-based approach, which best suits gas stations with a long trading history of reliable earnings growth, is calculated by dividing a one-year cash flow projection by the market capitalization (or market cap) rate.
The market-based technique, meanwhile, arrives at a valuation based on the going rate for similar private businesses and comparable share values.
Finally, discounted cash flow, based on the current value of free cash flow available over the life of the business, can be credibly used by both long established, low growth businesses and high growth, market entrants.
How to value a retail business
You may have a small, one-person operation or a large retail space with several employees. Regardless of your context, you will need to have clear, detailed records of your business in the years leading up to your valuation. Ensure you have records of your percentage of sales, the value of real estate or lease duration, fixtures and stocks.
You should also compare your business to similar ones to see how it fairs with them. Comparing your business to others will give you a holistic understanding of the fair market value.
How to value a professional service firm
Professional service firms – broadly defined as knowledge-based businesses such as legal, consultancy, and accountancy firms – are light on tangible assets and vulnerable to changing circumstances that weaken their intangible assets.
As such valuations are often based on projected earnings generated from historic trading performance, stellar reputation, intellectual property, products and services.
Much value also lies in the personal relationships between owner and clients.
Valuing your business with the ValueRight online tool
ValueRight is a free BusinessesForSale.com self-service valuation tool. To get all the benefits of the tool, ensure you provide as much information as possible when you begin the valuation. The process is relatively simple, and you can get a personalised valuation.
An advantage of using this tool is that your business will be compared to 20 years of BusinessesforSale.com data that will correctly benchmark and value your business. Inputting all your information into ValueRight will only take you around 45 minutes and all your information will be stored securely.
Before you start your valuation, remember to have access to at least a year's profit and loss statements. If you can, three years of statements will offer a more concise picture of your business and therefore, a better valuation.
The ValueRight service is free, and you can access it here. Once you have put in all the necessary information, you will be given a downloadable PDF report that you can keep, show to potential buyers or professionals who can evaluate the results. This document will be your business valuation report.
For more information, you can contact the support team.
Do you still need an accountant?
You can, of course, go to an expert to get a valuation of your business. It is vital that you find the right person who has the right experience. You should find out what experience and credentials any accountant has before getting them to value your business.
Although accountants can value a business, valuation agents can do the same. They can appear in various sectors like business brokers, lawyers, and chartered surveyors.
If you are concerned about financial obligations, ValueRight can give you an accurate valuation and you can proceed and list your business at a price that is fair and attractive to potential buyers. As we said before, this is a suitable, safe, and effective option if you are concerned about the cost of a business valuation.
Using ValueRight before approaching a professional will provide you with useful knowledge. Being as informed as possible will allow you to stay on top of anyone you hire and will take any uncertainty out of the process.
You will, therefore, already have an estimate of your enterprise value and you can be sure that the person you hired is doing it correctly.
Our rule of thumb
For over 20 years, BusinessesForSale.com has helped people buy and sell businesses, so we understand how important it is to value your business correctly. The valuation process can be demanding, but concise planning, preparation and research will make it far easier.
Always plan ahead. Knowing what you want your business's future to look like will be useful when you want to sell it. Develop a business plan that details what your business looks like, and how it can grow. A strong plan will maximize appeal, and it will show potential buyers that you are serious about the process.
Preparation is key. You can get a better valuation and selling price if you improve parts of your business that need attention. There are many ways you could do this: increase your brand's reputation and goodwill; look at ways you can reduce operating costs and boost sales; improve staff training procedures; upgrade software; organise your paperwork, administrative tasks and record keeping. Improving how your business functions is an important part of preparation.
Once you have done all the groundwork, make sure you utilise professional tools and resources to guide and help you along the way.Getting an accurate valuation that you are happy to advertise is the last step toward selling it for the best price. Achieving this on your own will be a challenging venture, so it is worth looking at our service directory to find appropriate business brokers, accountants, lawyers, and other business advisers.
The last step: good listing increases business value
Valuing a business is one step towards selling it successfully. The next step you will need to take is to advertise it on a platform that will give you the best possible exposure.
Adverts should prominently flag features that will appeal to buyers: a high footfall trading location; low rent or an easily transferable lease; a long track record of healthy, growing profits; unique and patented products; and availability of seller financing or owner willingness to stay on post-sale.
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