Valuing a business can be complex, but it is an important part of the process when selling your business. It can also help you with decisions you make whilst running your business.
Most people will have an annual valuation of their pensions and will get their house valued when remortgaging but will have no idea how much their business could be worth if they needed to sell it.
This is more important if you have business partners, what would happen if your partner is incapacitated or worse? Many cases their shares in the business will pass to their next of kin in which case you now have a new partner, how would you buy them out or how much should you ensure the partners for in case this happens?
As a sole owner of the business, you may also need to have a valuation if you got divorced or had personal financial issues as this can trigger the need for the business to be wound up or sold.
Valuation Methods
Each business will need to be valued differently, because each business is unique, and some valuations will give wildly inaccurate valuations, for example valuing business that is asset rich but cash poor would not be based upon future cashflow. Because the business has more assets than cashflow. Likewise an asset light company couldn’t be fairly valued on it’s assets.
Valuing a company using asset valuation with a lot of intangible assets is also very difficult as the value of these can be difficult to calculate and can be subjective.
Quick Valuation
For small businesses, usually below £250,000 profit, a simple quick valuation can be used. Which is based on EBITDA.
If the business is owner-managed I.e. dependent on the owner for functions and the owner has a role then a multiple of 1 is used, so effectively the owner would get the average of 1 years profit from the business. Assets generally are not included unless they are of significant value
If the business has a management team in place and the majority of the day-to-day operations are completed by them, then the valuation can be increased to a multiple of 3 times EBITDA depending on the level of autonomy of the management team.
A few caveats, the management team will need to have experience managing the business before the acquisition, if the team have less than 12 months this increases the risk and therefore decreases the multiple. Assets in the business are discounted unless of a high value. The machinery in the business that is used for day-to-day operation for example allows for the profit to be made, therefore without it would reduce the profit significantly. Personal cars held by the business can be included in the sale, or left with the current owner as part of the consideration.
Any debts in the company can either be left in the business, reducing the consideration for the seller or be paid off as part of the sale process. This allows for those assets that have loans against them to be used for finance as part of the deal. This includes directors’ loans that are either owed to the director where they have added funds to the business or where the owner has taken money from the business in the form of a loan.
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Asset Based Valuation
When a business has a lot of valuable assets or at least the value of the assets outweighs the valuation of the cashflow an Asset-based valuation can be used, this involves getting a current asset value of all assets within the business, usually looking at book resale value
Types of Asset
Tangible
Tangible assets are those which can be touched, they include
- property,
- finished stock,
- raw materials,
- work in progress
- vehicles
- machinery
- computers
- and anything that has a physical presence and a value
Intangible
Intangible assets are harder to value and are those assets that are unable to be touched but provide value to the business.
- Customer loyalty
- business reputation
- Internet domain
- Social media
- branding
Intangible assets are much harder to value because of their nature so a figure is agreed with the seller.
Discounted Cash Flow
A discounted cash flow is also known as discounted future earnings and takes into account the value that the business is projected to make over the next 10 years, and then discounts this to take into account inflation and the potential risk of those earnings.
So if a business is selling products that are lifestyle-based and in fashion this may represent a higher risk to the future cashflows of the business because fashions change. however, if the business is selling products and services to other businesses that require them like accountancy practices this would be seen as a minimal risk
The level of risk involved with the future can also be affected by the government, changes to the government in the near future may change the risk factors, but also other considerations like consumer confidence in an industry. If the business works in a heavily polluting industry for example there is a push not to become cleaner which will limit the profitability of the business.
This method is great when the business does not have a lot of history, for example, if it only has 2 years’ worth of trading you cannot use historical methods to value the business. It also works where the business is experiencing growth and the owner is looking to extract some of that themselves.
Adjusted Net Assets
For businesses with a large asset base, valuations based on the value of the assets can provide the fairest valuation. This is particularly true where the value of the assets outweighs the earnings within the business.
For example, if the business is a hotel, the value of the physical building may be much higher than the valuation of the business using any other method.
To calculate the value of the assets, it may be required to get an independent market valuation, for specialist machinery or equipment, a specialist valuer may be required. This may also include assets that are not specifically on the balance sheet. The total amount of liabilities is then subtracted from the asset value to give the adjusted net asset valuation.
It is important to get a correct valuation of all the assets and liabilities, this valuation method is therefore very subjective and can result in a lot of negotiation of the values, this can be difficult as both parties are trying to achieve different goals, if the negotiations are difficult it may be worthwhile to bring in experts into the process to ensure the valuations are independently verified.
The liabilities may also be negotiated as some may need to be cleared prior to any sale as there may be stipulations within the contract or personal guarantees that are not able to be removed.
Market Valuation
The market valuation method is very similar to the property market where businesses are valued based on the sold value of comparable businesses. The issue with this is that the numbers involved in the property market are much larger, in the UK approximately 750,000 properties are sold in a year. There is then the complexity of businesses which may be in the same industry but may be set up completely differently.
Many brokers may use this method and utilise the for-sale price as a comparison however this value could be vastly different than the value achieved in the sale of the business, there is no method to obtain the sold value of privately traded businesses as this information is not needed to be centrally registered in the same way as property sales. which results in this method relying on either deals the valuer has been involved in, or public sales via the stock exchange.
The publicly traded companies are those on the stock exchange, however they are usually significantly larger than privately traded businesses so
Deductions and Add Backs
When a business is valued based upon it s profits, for example the quick valuation or others based upon profits, it is usual for a business to have some deductions or add backs to this valuation.
A valid deduction would be some known expenses that are needed to be incured by the business to continue trading. For example if the business had end of life vehicles which were required for the operation of the business it would be valid to deduct the valuation of this vehicle to the price as the business would have zero value without the ability to operate.
For Add Backs, thes can get creative, where a business has a lease vehicle which has been used by the owner, or in some cases the owners family, it would not be expected for this cost to continue within the business after the owner has left, in many cases the owner would take with them the vehicle in question anyway.
Another regular add back which can boost the value of the business is the directors renumeration, in some cases this can result in the entire profit of the business especially when the it is owner operated.
However, this should then result in a deduction for the replacement value of a director for the business. Otherwise the new owner would be working for free within the business.
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