Valuing a Business: What You Need to Know
Are you in the process of valuing a business?
Anyone who wishes to sell or raise capital on a business needs to be able to make a fairly accurate valuation of that business. Find out how.
- A Comprehensive Guide to Business Taxes
- How Should I Account for My Own Investment into My Startup?
- How to Avoid Inheritance Tax on Business Property
Anyone who wishes to sell or raise capital on a business needs to be able to make a fairly accurate valuation of that business. Arguably, it’s not just those who want to sell who should have their eye on the value either. The value of their business is something that every business owner should be aware of.
But how do you go about valuing something that includes so many intangible features and possibilities? There are a number of different ways to value a business, which suit different individual sale requirements.
The most simple and straightforward way of valuing a business is to add together all its assets and come up with a figure. The assets include any buildings, equipment, stock, and raw materials owned by the business, and anything else that belongs to that business at a given time. Once those are tallied up, the resulting figure is your value.
The assets include any buildings, equipment, stock, and raw materials owned by the business, and anything else that belongs to that business at a given time.
What results is a fairly accurate representation of the face value of what you own, but it isn’t the full picture of your business value. This is probably the figure you need if you’ve decided to shut the whole thing down, but it doesn’t account for selling your business as a going concern.
If you want to sell your business to someone else, if you’re retiring for example, then using some sort of cash flow based value is best. This method takes account of all the expected future revenues and costs, as well as the capital assets. It involves making an estimation based on what the business is likely to earn in the future, which can be done in a number of ways.
Valuing a company based on turnover
Typically you’d run a projection for an appropriate period into the future, say five years, then factor in any risks to the venture. In theory, this is the best way to value your business’s potential for onward sale, but it’s a complicated method and prone to mistakes, as well as over (or under) estimates.
In theory, this is the best way to value your business’s potential, but it’s a complicated method and prone to mistakes, as well as over (or under) estimates.
Another way of doing a cash flow projection is to look at your previous year’s performance, add in the net profit, and multiply it by the business category related multiple. A multiple is applied to different business categories to establish their likely value, reflecting the fact that most businesses are literally worth more than the sum of their parts.
This multiple would normally be about two times for a small service business, or three times for a small manufacturer, for example.
Consider intellectual property
This brings us to the thorny issue of what it is about a business that holds the value, and whether that will carry through a sale. In other words, what will a change of ownership entail for the business’s viability? Worth is calculated by how much a buyer is likely to make from the business, offset by the risks involved. Past profits and asset values are important, but customer goodwill towards the proprietor and intellectual property can also make a difference.
How to value a business quickly
If all else fails, another reasonably reliable way of valuing a business is through a straightforward comparison with other companies. Find a business similar to yours that was recently sold, and adjust the value of that transaction to reflect circumstances particular to your own business, such as location, and present day economic reality.
Valuing a business: rule of thumb
Ideally, when valuing a business, you’ll want to use two or more of these methods and cross reference them. This will provide a more detailed, accurate, and trustworthy valuation with more weight when it comes to entering into negotiations or transactions.
You can only sell your business once, so it's vital you get it right. Clark Howes’ partners are business people in their own right and between them have bought and sold numerous companies and businesses. This experience can help you through every step of what can be a difficult and stressful time.