How to value your business - A guide for small businesses
You’ve poured endless energy into your business. Now, how do you put a value on what you’ve done? What is your business worth? Which methods could you use to value your business and which would you prefer? This guide can help you to put a valuation on your business that’s credible and reflective of all your hard work.
Why put a value on your business?
One of the most common reasons for putting a valuation on a business is that you’d like to explore the options for selling it, or for selling shares in it. But if you’re seeking investment or additional funding then a valuation can help to establish the business’s
Does your business need a valuation?
There’s a thriving market for small businesses that have potential and the right people; a proprietary idea or piece of technology; or a good track record of trading and a sound reputation. And if you’re thinking about growth, expansion, or business funding, then a recent valuation might be key to getting the money you need.
By choosing an appropriate method for valuing your business, you can highlight the aspect of your commercial model that, in your opinion, makes the most significant contribution to your bottom-line.
However, much like buying or selling a house, there’s also a general rule of thumb that a business is only worth what people are willing to pay for it. An investor or lender may want to explore other valuation methods. But with the groundwork done, you should be in a position to evaluate their figures against your own. Multiple methods of valuation all contribute to a negotiation.
What affects the valuation of your business?
Much depends on who’s carrying out the valuation, and why. But there are six common influences that most appraisals take into consideration:
Growth prospects for the business
Quite simply, can your business grow? Regardless of what’s happening in the industry, or how your customer-base looks today, does your business model support growth potential? If it does, this could have a positive impact on the value of your business.
Your recorded income and profits
It may seem obvious, but your business’s trading income and the profit-margins you’re seeing can be a major factor in the valuation of any business. That said, some businesses experience dips in their cash flow that might not have a huge impact on a valuation.
Business premises and assets
If you’re not working from home, you’re working from commercial premises, then your business’s location may play a role in valuation: for rental potential, as a tangible, saleable asset (if you own the property or the land), or – if your location impacts your sales – what your proximity to a customer-base says about potential for growth. Also consider the assets that you have in the business, such as vehicles and equipment, as the age and condition of these can affect the value, particularly if the buyer needs to invest additional funds to replace old or unreliable items.
Appraisers can sometimes consider the notion of ‘having all your eggs in one basket’ as an influence on the valuation of a business. If you have a few, large, key clients, then your business may be dependent on the sustainability of those relationships. If you have many disparate customers, then your business may find strength in diversity – but be using valuable resources to manage and account for customer ‘churn’.
Your staff and company culture
The team that’s helping you to run the business today may change tomorrow. Many appraisers may explore the likelihood of key personnel leaving a business.
The business’s reputation
These days, in the age of social media and digital ‘everything’, your business’s public reputation can be assessed quite easily. An excellent reputation could boost the value of a company, while poor reviews or views on your culture could bring the value down and make it harder to sell.
The circumstances of the valuation
Clearly, if you’re in a poor negotiating position (going through administration, for example), then the valuation may not be as favourable.
Crucially, if you’re thinking about getting a valuation, it pays to be prepared for different opinions on what your business is worth. The money that you’ve invested to date may not be reflected in the final appraisal.
For example: imagine you’re running a small haulage firm. You’ve recently decorated your premises and put up new promotional hoardings. A sign may have cost many thousands of pounds – but unless there’s a tangible link between better local visibility and increased trade, then the sign’s cost may not be reflected in the final valuation.
How to value your business
Different industries adopt their own approaches to valuation. To arrive at a solid and agreeable figure, appraisers may use one or more methods. If you’re talking to potential investors or lenders then it’s worth exploring which methods they’d like to use and why. These are the most common approaches:
A multiple of profits
The appraiser may look at your average monthly and annual profits. These might be adjusted to remove things like large capital expenses or large one-off sales. This view of your profits can indicate whether your business is healthy and likely to grow under the current circumstances.
These figures are generally known as ‘normalised’ profits. The overall valuation of your business takes that figure and multiplies it, usually by a factor of 3, 4 or 5. For smaller businesses – those affected quickly by changes in a market – an appraiser may use a low multiplier; for large enterprises with longer-term strategies, the multiplier may be as high as 7 or even 8 times the normalised profits.
NB: The multiplier is based on a number of areas, including those noted above, market conditions and comparable sales evidence from similar businesses
Valuing your tangible assets
Your accounts should show what you’ve brought into the business in the way of inventory, and which tangible assets still belong to the business. Factoring in depreciation, appreciation and inflation, this net value (total assets minus total external liabilities) can be used to evaluate businesses that trade in stock.
Discounted cash flow
This valuation method takes future cash flow projections into consideration. Discounted Cash Flow or DCF analysis looks at how attractive an investment opportunity in the future may be by contrasting it with trade at the present (it’s a way of estimating the value today by looking at projections of how much money the company is expected to make in the future).
Entry cost valuation
This is the amount of money it would cost to build up your customer base, collect your assets, recruit a team of people, train them, and develop your products or services from scratch.
Price / earnings ratio
A price/earnings ratio (P/E ratio) is the value of your business divided by its profits after tax. For example, if your business has a share price of £50 per share, and the earnings for each share after tax are £10, then it would have a P/E ratio of 5 (£50/10 = 5). The value of your business is then calculated like this:
Value = Earnings after tax × P/E ratio
Once you’ve calculated the P/E ratio, you multiply your business’s most recent profits after tax by that figure. So with a P/E ratio of 5, for example, a business that has post-tax profits of £100,000 will have a value of £500,000.
Ask for advice to get a fair valuation
Buyers and investors may listen to your thoughts on a valuation. It’s easy to suffer from cognitive bias during the process – the notion that your business is worth more to you than to someone else. If in doubt, it can pay to have experts working alongside you in a neutral capacity in advance: asking independent consultants to give you a valuation and explain in detail how they’ve reached their conclusions.
Please note that these guides are provided for information purposes only and not as advice or recommendations. Before deciding to undertake any course of action you may wish to seek independent professional advice.