It’s often said that the value of your business is what someone is willing to pay for it, but there are several approaches you can deploy to reach an accurate figure. Here our small business accountants explain how to value your small business accurately, before giving some information on our company valuation services.
Valuing a business or knowing your company valuation isn’t only useful for business owners and entrepreneurs looking to buy or sell a company. A company valuation can help when:
Securing investment – think of Dragons’ Den, where investors want to see a realistic figure and value in the deal you give them
Setting a fair price for employees – if your employees want to buy and sell shares in the company
Growing or expanding your business – an annual valuation helps to secure funding and focus your energy on areas for improvement
Ultimately, you want to reach a company valuation that doesn’t sell the business short. It also shouldn’t overstate what the business is actually worth.
It’s tricky to find a balance – if you’re finding the company valuation easy, you might need to revisit your method. It’s a good idea to combine a couple of business valuation techniques.
While there are some parts of a business you can value easily, there are always going to be intangible assets.
Beyond stock and fixed assets (like land and machinery), which are tangible and have clear value, you should also look at:
The business’s reputation
The value of the business’s customers
The business’s trademarks
The circumstances surrounding the company valuation (like a forced sale rather than a voluntary one)
The age of the business (think startups making a loss that have lots of future potential, versus established profit-making companies)
The strength of the team behind the business
What kind of product you have
These intangible assets make it fairly difficult to reach an accurate company valuation, but there are a number of techniques you can use to make it easier.
While there are different business valuation methods and not one formula for valuing a business, the majority of businesses are often valued by their price to earnings ratio (P/E), or multiples of profit. The P/E ratio is suited to businesses that have an established track record of profits.
Working out an appropriate P/E ratio to use can be driven by profits – if a business has high forecast profit growth, it might suggest a higher P/E ratio.
And if a business has a good record of repeat earnings, it may have a higher P/E ratio, too.
As an illustration, using a P/E ratio of four for a business that makes £500,000 post-tax profits means it would be valued at £2,000,000.
How you arrive at the right number for your P/E ratio can vary dramatically depending on the business.
Tech startups often have high P/E ratios, because they’re usually high-growth companies. A more common high-street company, like an estate agency, will have a lower P/E ratio and is likely to be a mature business.
And as the shares of quoted companies are easier to buy and sell, they’re more attractive to investors. Smaller, unquoted companies usually have around a 50 per cent lower P/E ratio than their quoted counterparts.
Because P/E ratios differ wildly, there isn’t necessarily a ‘standard’ ratio that can be used to value all businesses. Having said that, a business adviser might suggest a valuation of four to 10 as a P/E ratio.
Related: Profit And Loss Forecast Template
This is a simple one – how much would it cost to set up a similar business to the one being valued?
You need to factor in everything that got the business to where it is today. Make a note of all the startup costs, then its tangible assets. How much would it cost to develop any products, build up a customer base, and recruit and train staff?
After that, think about savings you could make when setting up. If you can save by locating the business somewhere else or by using cheaper materials, subtract that from the figure. Our small business accountants or online accountants can help you with cashflow and saving money.
When you’ve taken everything into account, you’ve got your entry cost – and a business valuation.
Stable, established businesses with a lot of tangible assets are often suited to being valued on these assets. Good examples of businesses like this are those in property and manufacturing.
To do an asset valuation, you need to start with working out the Net Book Value (NBV) of the business. These are the assets recorded in the company’s accounts.
Then, you should think about the economic reality surrounding the assets. Essentially, this means adjusting the figures according to what the assets are actually worth.
For instance, old stock depreciates in value. If there are debts that aren’t likely to be paid, knock those off. And property could have changed in value, so refine those figures, too.
Read More: Statutory accounts
This brings us round to what we said at the beginning – a business is worth what someone is willing to pay for it. Intangible assets mentioned earlier could be considered here, with negotiation skill playing a part, too.
If the business has desirable relationships with customers or suppliers, it might be more valuable to a buyer.
If the buyer doesn’t have a stable team behind them to take the business forward, a strong management team (that won’t jump ship) could also add value.
And each prospective buyer might see different risks, variably lowering the value. The key as a business owner is to pre-empt any risks and minimise them.
Many tangible and intangible factors influence the value of your business. By focusing on the factors that are important to potential buyers or investors, you can increase the chances of a successful sale and boost the value of your business.
This demonstrates to buyers that you have a strong grasp on running and growing your business. You are showing that the business is built on solid operational, management and financial foundations with a clear forward-looking view and roadmap for growth.
With a solid business plan you can show your focus on how you’re going to achieve both short-term and long-term results. At Accounts and Legal, we can help you put together a well considered business plan which will allow you to plan and formulate realistic and accurate forecasts. We also have legal and marketing consultants in-house to assist with key non-financial aspects of a well rounded business plan. You can find out more about that here.
Buyers are unlikely to take a risk on a business in poor financial health. Get a clear picture of your key numbers and present them in a way that shows you have a stable business and strong financial management in place. Offer buyers documentation that supports your claims.
Similarly, it's important to reduce risk: for instance, if you rely on a particular group of customers, consider diversifying.
Buyers may be concerned if the business depends on just one person – you, the owner. By introducing other key figures in your team and providing biographies, you can show that there will be continuity in the business, even if you leave.
By demonstrating a track record of innovation and new product development, you show buyers that your business has a strong culture of teamwork that will help to open new opportunities and a continuing flow of new products for growth.
Similarly, start putting great processes in place: think about how you store information, whether it’s financial records or simply how the business works. Often, the more you can show, the higher the confidence in the business.
A strong supply chain will be essential to the continuing success of the business. Show buyers and investors the depth of your supply chain, the commercial relationships and the procedures you have in place for managing quality.
A buyer wants to know that the business has growth potential. A clear market strategy, backed by research on the structure, historical growth and long-term opportunities in your marketplace will give buyers confidence that they will be competing in a strong market.
Few buyers are looking for a ‘me too’ business. They want to know why your business is different and what makes it a success in your target market. What are the features and benefits of your products or services that your competitors cannot match? What patents or copyrights do you hold to protect your products? Why are you able to compete in higher value sectors of the market?
By looking to the future and explaining how your product range could diversify into other growth sectors, you show buyers that your business does not have limited growth potential. Explain how your current range can grow through line extensions, entry into new sectors or launch of customer services, for example.
A business with a diverse group of loyal customers is a more attractive option than one that depends on a few large customers. Buyers know that the loss of a major customer could prove damaging to the business. It’s also important to show how your sales and customer service operations are set up to build strong long-term customer relationships. In your sales records, aim to show high levels of repeat business.
Press reports, industry awards, speaking opportunities and thought leadership communications show that you have built a strong profile for your business and established a reputation that puts your company front of mind when customers are selecting new suppliers.
All of these factors will demonstrate that your business has a strong foundation and attractive growth prospects – factors that give you a great bargaining positioning when you come to negotiate the proper value for your business.
As we mentioned earlier, company valuation services can help you focus on areas for improvement.
But remember: what works for one business won’t always work for another. By giving an overview of several popular business valuation methods, though, you should have a better idea of what your business is worth.
Do you want professional help on how to value your business? Get in touch with our MBA-qualified business consultants and solicitors today, we can offer expert company valuation services, plus give advice on how to maximise the value of your business.