How to value a small business
When it comes to selling your business, the first thing most owners want to know is, how much is it worth?
Is there a standard method, formula or approach to valuing a business?
There is no single formula which is accepted and used in the process of valuing businesses. Obviously a business seller will seek to drive the price up, whereas any possible business buyers will seek to get the valuation and price reduced.
Other factors also come into play in most sales of small businesses. Sale price may well be linked to whether, as seller, you are prepared to accept any deferred payment, earn outs, to stay on in the business. All these issues can fundamentally impact business worth, as can tax efficiency on business sale for both buyer and seller.
If you need assistance in valuing a business, whether as potential seller, buyer or for other reasons, or strategic or negotiating advice in this area, please do get in touch. Our team includes not only experienced and competent accountants but also strategic business advisors and legal consultants.
Valuation for sale, investment or other reason?
We have clients ask for our advice and assistance on valuing their businesses for lots of reasons, not just with a view to sale. Applying for finance from a bank or other 3rd party may require a valuation. In that case, it is often sensible to be more conservative in the valuation than on a sale. A valuation will be needed where private equity investment is sought.
Another quite common scenario is where a business or company needs to be valued because there is a shareholder dispute and one or more of the shareholders or business owners will buy out the other shareholders. In this situation, the method of valuation may be very different to selling the entire company or business to an unconnected 3rd party. We can assist whatever the underlying position and commercial reality.
Tangible and intangible business assets valuation on business sale
Some parts of a business are more straightforward to value than others. Tangible assets are physical assets which can be counted, tested or measured for value. Examples of these types of assets include stocks, machinery and equipment.
Intangible assets are far more difficult/contentious in terms of values and many businesses, in the digital age where IP is a major asset for almost all businesses, there will very probably be a sizeable intangible element to the value of a business. Intangible assets can by their very nature by difficult to value.
The intangible assets typically include :-
- Market share, competitors and threats
Business or industry specific valuation factors
- Profit growth rate – from a potential buyer’s point of view a key factor.
- Reasons for sale – if the buyer senses or knows that a seller needs to sell this will likely impact value. Consequently, timing can be a very important factor, especially for a family owned business.
- How many interested prospective buyers? If there are several, this will create good prospects for achieving a higher sale price.
- Technological or competitive advantage – businesses which have very or potentially very valuable IP or a clear competitive advantage or where barriers to entry for competitors are high are likely to be valued higher than others.
- Reliance or overreliance on a small number of customers – this may be considered a risk factor.
- Key staff – how much is the business success down to 1 or a few key staff?
- Contracts – are they long term and well drafted? If the business is potentially more valuable/attractive in parts and not the whole or if it is not set up as a limited company (in which case the buyers may just buy the shares and the entity stays the same), it may be necessary to transfer existing contracts from the current owners to new owners. This may or may not be possible legally as of right. It depends on what the existing contracts say, if anything, about assignability.
- Owner run businesses tend to get a lower price/earnings valuation as they are seen as being owner dependent - when the owners leave, there is a significant risk that the business will diminish.
- Consistent profit of over £500.000.00 - generally means a much better price earnings ratio valuation, often more than 5, whereas less than £500.000.00 likely to result in a valuation on a price to earnings multiple of less than 5.
Negotiate on valuations
It can be easy to think that having an accountant value your business gives you a figure you can steadfastly demand is used on any sale or fund raising. It rarely if ever works that way. Accountants and corporate fiannciers/advisors will often come up with different figures but above all, the value of a business is arguable and negotiable. So, it’s essential to anticipate that any valuation will be subject to likely negotiation. Having a good negotiator and a clear strategy in place are strongly recommended. If your valuation is challenged, what areas are you prepared to concede or reduce?
How do venture capitalists value businesses?
Venture capitalist and professional investors take a slightly different approach. They too think about multiples of profit which they get from analysing comparable companies, but they plug this value into their exit valuation rather than their entry valuation.
They start with a financial projection that they think is achievable. Using this rate of growth, an exit multiple from sensible comparable companies and a pre-determined rate of return, they can calculate the amount they would be prepared to pay.
For this reason, selling a high growth business to a VC can be much more or less lucrative than selling to another trade player.
So how much is your business worth then?
There are lots of factors and potential valuation methods that influence value (including several we haven’t mentioned here), but if we assume that a business is profitable and has steady growth of perhaps 4 – 8% EBITDA and limited spend in terms of capital expenditure (in other words its levels of profit are similar to cash flow), then the price is broadly a function of EBITDA.
Based on our experience, we’d expect a business with annual EBITDA of £100k to be worth perhaps 4x EBITDA, a business with EBITDA of £1m might achieve a multiple of 6x, whereas a business with perhaps £5m EBITDA might well achieve 8x EBITDA.
Small business valuers in London
We would be happy to advise and assist. We also have excellent negotiators and strategists if you are selling or buying because there is no set way to value a business. Our charge rates are also highly competitive and attractive compared to traditional corporate finance and/or other advisors.