While it may be true that your business is worth what someone is willing to pay for it, that’s hardly a solid foundation for planning a sale and you need to know how to value your business.
There is no definitive formula for valuing any particular kind of business. However, there are several common varieties, sometimes used in conjunction, and the appropriate one for your business very much depends on your sector.
Let’s look at some common methods used to arrive at a small-business valuation, and help you get the best price when selling your business.
Times revenue method
This method applies a multiple to your current revenues to arrive at a maximum price your business could realistically be sold for – termed the “ceiling” value. It is often used in conjunction with a “floor” value, which is the liquidation value of your business assets.
Taken together, these benchmarks define a range within which the sale price of your business would be expected to fall.
Though perhaps lacking the sophistication of some approaches, the times revenue method still allows for adjustment of the multiplier to reflect other strong or weak business features. For instance, a multiplier of 1.5 might be revised downwards in light of a competitive disadvantage like a lack of brand awareness, or set higher where the company is soon to benefit from trading advantages – for example a piece of legislation in the pipeline that favours your business or industry.
Asset valuation method
Most commonly applied to well-established, asset-rich enterprises, an asset valuation calculates the value of balance-sheet assets – often termed a net book value (NBV). This gross asset figure is then revised to allow for: outstanding liabilities such as business debts, the depreciation of certain fixed assets, any appreciation in property values, plus discounts to reflect the declining worth of obsolete stock.
Entry cost valuation method
Another approach that is relatively straightforward to quantify, the entry cost method estimates how much capital it would take to launch and develop an enterprise into one equivalent to the business being put on the market.
Such costs include those related to premises, product/service development, staff recruitment and training, marketing required to create and sustain a similar customer base and so forth.
A prospective buyer could attempt to reduce the price by arguing they could do it more cost-effectively. For example, they could produce goods more cheaply with upgraded equipment, point to similar businesses that enjoy comparable success with fewer employees, or buy premises in a cheaper location where location is not central to the business’s fortunes.
Price/earnings ratio method
The price/earnings (P/E) ratio is calculated by dividing the business’s share price by its post-tax profits, and is one way to value your business.
Some industries have widely used P/E ratios, but many have none at all. In general, however, hi-tech sectors tend to attract higher ratios because of their propensity to grow fast. Ratios for small firms tend to be lower than for large businesses on account of a higher perceived risk.
Thus, your advisory team could propose a valuation based on a P/E ratio of anywhere between four and 10 times your annual net-of-tax profit.
While fixed assets, such as premises, land and equipment, are easily assigned a value based on the typical values of similar assets on the market, intangible assets are more problematic. It is for you to present a strong case demonstrating the strength of elements like intellectual property, goodwill and brand recognition to value your business.
The subjective nature of valuing intangible assets helps explain the huge disparity that often exists between an initial valuation and the final, negotiated selling price.
Talented, sought-after staff; secure, longstanding relationships with key customers; preferential terms from important suppliers; a strong reputation evidenced by positive scores on social sentiment analysis; plus patents and other intellectual property can really make a difference to the sale price.
Due diligence and other factors
Like any sale, business acquisitions are subject to prevailing market conditions. Your advisors will explain these trends and help you devise an appropriate selling strategy for that climate.
Other factors which could have a bearing on your final valuation include your reason for selling (where the need for a quick sale may force you to compromise), and the number of years you have been trading (where being ‘young’ with a limited financial track record will depress the valuation, while a profitable, long-established concern should command a premium).
And lastly, any significant discrepancies revealed during the buyer’s due diligence process will likely prompt a downward adjustment of the intimated purchase offer, or at least become the focus of a negotiation with that aim in mind. For example, few buyers would meet an asking price – or even, perhaps, continue negotiations – based partly on strong brand image if they uncover a reputation for poor customer service.
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