How are businesses valued?

How are businesses valued?There are many reasons why you should consider valuing your business, the more obvious of the reasons may be as you approach the prospect of selling the business, or you may be splitting from your business partner and need to know the value of the business to buy him or her out. Whatever the reason, you should seek professional help to value any business. This article is designed to talk you through the approaches a valuer would take to value a business as well as spelling out some of the pros and cons of business valuation.

There is a phrase in our industry, ‘a business is only ever worth what someone is willing to pay for it’. Well, in my opinion this is absolutely correct. If there isn’t a buyer out there willing to pay the price of the business in question, then the business simply isn’t worth the money you are asking for it. That said, for the purpose of a valuation for loan or security purposes, whether a buyer is out there who is willing to pay a particular price, can only be determined from historic transactions for broadly similar businesses, namely, comparable evidence. It is essential to note that valuation is only ever a starting point for negotiations to commence. That said, there are of course instances where that isn’t the case, but when it comes to selling a business, it is just a starting point.

I think it is essential, whether starting out in business or indeed having been in business for some time, that you know well in advance, preferably from the beginning what the exit strategy is going to be. If that could be through selling the business, then build your business with selling in mind and regularly assessing the strength and growth of your business by its sale price is essential to achieving maximum potential when selling.

I am often asked when the best time to sell is. Frankly, I couldn’t honestly say to sell in January is better than to sell in December. The best time to sell is when you are prepared and ready. Of course, depending on your business, seasonality may well play a part, but primarily, your business needs to be ready for sale. Too many sellers go to market ill prepared for sale and, guess what; they never achieve maximum value.

There are many number of ways to value a business, depending on the buyer and the industry norms. For the purpose of generality and application to a broad spectrum of business types. we will look at two areas, multiple of profits (EBITDA to be exact) and Asset value.

EBITDA Multiple

EBITDA stands for Earnings Before Interest Tax Depreciation and Amortisation. EBIT, i.e. Earnings Before Interest and Tax is essentially the businesses Operating Profit or Net Profit before any tax or interest charges are deducted.

Depreciation and Amortisation are accounting principles that allow the writing off of tangible and intangible (assets you can touch such as a desk or a machine and assets you can’t touch such as goodwill) business assets on the balance sheet by applying a cost to the profit and loss account which represent an annual cost of the particular asset based on its perceived operating life. For example, a company van that is bought for £25,000 and perceived to last 5 years will be charged to the balance sheet at £5,000 per year for example.

Multiples vary with sector and the businesses position, but essentially the EBITDA multiple is exactly what it says; a multiplier that is multiplied against the EBITDA figure. It is worthy noting, that one off and exceptional costs should always be added back in to EBITDA too, although there is no acronym for this.

It is possible to see a wide range of multiples used in business valuation, from one times EBITDA to twenty odd times. For the majority of small, owner operated businesses, you would be looking to achieve between one and three times EBITDA. A good broker can share actual sale prices and multiples with you which means you know the price you are asking is a good negotiation starting point.

Asset Value

Where the assets of the business are worth more than the EBITDA multiplied sum above, it would be unrealistic to use the multiple valuation method. Instead, the value is in the assets and so you would want to sell the assets for current value.

If you are a limited company, you may need to do certain things to prepare for sale, such as reconstituting your balance sheet, i.e. bringing the actual value of fixed assets for example up to date to reflect the market value of those assets rather than the artificial depreciated value that your accountant has put into the balance sheet.

If you are a sole trader or partnership, i.e. not a limited company, you will simply need to make sure you know the value of your assets and ensure they are free from any encumbrance, namely finance agreements or other restrictions.

In reality, a sole trader or partnership could value the assets themselves by looking on the internet to get valuations of similar assets. You may achieve a small premium for the fact the business is in situ and trading so again, seeking advice is key to achieving the best value.

Top Tips for success:

Build your business with selling in mind.

If you intend to sell, don’t leave it until you’re ready to take the plunge to prepare the business, it can take atlas three years to properly prepare for sale. Too many business sellers are ill prepared for sale and, guess what, they lose value!

Don’t make yourself indispensable

A business owner that does all of the work is, by all accounts, all of the business. If you have staff, use them wisely and try to build a business that could easily operate without you. The more reliance the business has on you to succeed; the lower the value will be.

Accounting for the tax man

I hear so many times, that a businesses accountant shows the accounts in the best possible way to save tax. So often, this results in lower stated profits. If your business is making money, then why wouldn’t you pay the tax that’s due. In any case, whatever your stance on this topic, the more you can show in the bottom line in the few years leading up to sale, the better and the more you will get at sale. If you’re not prepared to do that, be prepared to take less when selling it’s that simple.

Get advice

A good advisor is essential. Someone with experience in your sector and who has handled the sale of similar businesses. A final point, if you instruct professional advisors, check the terms of business because all too often they contain cancellation clauses. Also, don’t be wowed by an over exuberant asking price, check the market and see what else is for sale similar to compare pricing and never be afraid to ask for real examples of sold prices.


Powered by

Up ↑