What's the best way of valuing your business?

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In the latest UK200Group blog post Simon Blake, Partner at Price Bailey discusses how crucial it is to understand what your business is worth when considering selling your company.

Simon Blake
If you're considering selling your company or looking to attract new investment as a way to achieve business growth, it's crucial to understand what your business is worth.

It's also important to recognise that there's more than one way to value a business, and choosing the valuation method that puts your business in the most attractive light to a potential buyer or investor can positively influence the final price or investment terms you achieve.

What are the main methods of a business valuation?

Discounted cash flow: This income-based approach values your business using estimates of future cash flow. It's based on the theory that the value of your business is equal to the current value of its projected future benefits, including the present value of its 'terminal' worth (the terminal value doesn't assume the end of the business, rather it represents a point in time when the projected cash flow levels off or flattens out). If you use this method, it's essential to take into account inflation – many business buyers will use a discount rate of 15-25% to incorporate changes in inflation into the calculation.

Asset valuation: One of the simplest valuation methods; this is based on the net book value of your business – i.e. your total assets minus total liabilities. Particularly suitable for asset-heavy companies (for example, those involving substantial or multiple properties), it's unlikely to take into account inflation, depreciation, appreciation, goodwill and IP.

Entry valuation: Another straightforward valuation process, this approach looks at how much it would cost to build up the assets, people, training, customer base, and products and services that are contained within your business. While easy to use, it reveals nothing about the future performance or earnings from the company, so what it gains in simplicity, it loses in lack of accuracy in expectations of future cash generation

Rule of thumb: Each industry has its own rule of thumb to determine businesses value. For example, retail companies are often valued as a multiple of turnover, hotels based or revenue per room. These also often rely on a sector or industry multiple. We cover more on that below

Earnings or profit multiples: The most common basis for profitable trading businesses, this takes the adjusted average monthly profits (which accounts for several kinds of expenses and income streams that shift when a business changes hands in addition to a company's bottom line) or annual profits of the business, and then multiplies that figure by the profit multiple' to give an accurate business valuation. So business profit x profit multiple = value.

While the 'profit multiple' method may be more complicated than most, it can give potentially greater accuracy in business valuations and is particularly beneficial for businesses with a track record of profitability.

However, it's essential to understand some of the crucial issues affecting the multiples used to value a business in different sectors. Many companies are valued on a multiple of 'Earnings Before Interest, Tax, Depreciation & Amortisation' – known as EBITDA. The most appropriate multiple to then attach to your company's EBITDA is one that derives from comparable businesses that have also been sold – particularly those that most closely match your company in both trading activity (sector) and size. The valuer also needs to take into account when the transaction happened (cycle), and how it is funded – is it debt free? Does it own or lease its assets?

So, how much are companies worth?

So sector, size and cycle all play a crucial part in determining the profit multiple. However, as a recent report published by Price Bailey titled how much are companies worth explained, those three factors alone can exert a massive influence on the final valuation of your business. For example, the average profit multiple in the UK software sector last year was 15.3x, but the multiple for the industrial support services sector was 7.1x. So while a software business with annual profits of £100,000 may be valued at £1.53m, a support services company with double the annual profit may only be valued at £1.42m.

With profit multipliers taking into account everything from the dependence on the business owner, or the uniqueness of any systems or technology the business may use, to the strength of the brand and opportunities for expansion, it's no surprise that the calculations may be quite complicated. However, if the profit multiplier approach could generate an accurate, higher value for your company, it's worth seeking expert advice to enable you to secure the best sale price or investment option.

For more support and advice on the most appropriate formula for your business valuation, and how to work out what your company is worth contact Simon Blake a Strategic Corporate Finance Partner at Price Bailey.

Tags: UK200

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