When you’ve put so much time, effort and hard work into building a business, it’s vital, for numerous reasons, that you have a true idea of its worth. An accurate business valuation helps you secure new borrowing, unlock investment and sell for the right price.
With many different business valuation methods you can use, it’s all too easy to overvalue your business or sell yourself short, and both can lead to adverse consequences. So, how do you get an accurate business valuation? We discuss what the process involves, the best valuation methods to use and why it’s so important to find the right price.
What is a business valuation?
A business valuation is the process of determining the market value of a company. Although that sounds simple, the process is rarely straightforward as there are so many factors to consider. Things like the business’s tangible and intangible assets, its reputation, its profitability, how well-established it is and the debt it carries are all pieces of the puzzle.
Factors outside the business can also impact its value, such as the performance of the local and wider economy and the level of demand for its products and services. No single company valuation method takes all of those factors into account. That’s why the valuation methods are often combined to reach a more comprehensive figure.
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Why is a business valuation important?
Understanding what your business is worth is important for many reasons. It enables you to:
- Sell the business for a fair price and negotiate with prospective buyers
- Secure financing deals without overpaying
- Determine the financial health of your business and its potential for survival and growth
- Identify the strengths and weaknesses of the business
- Set a fair price when buying and selling shares in the company
- Provide accurate figures for tax returns and insurance policies
Who can value a business?
Given the importance of an accurate business valuation and the complexity of the process, you should use a professional business valuer. Although some accountants provide business valuation services, a business transfer agent or broker with specific experience in your sector and location is your best bet.
Business transfer agents - like our team at Eddisons - are business valuation specialists. They have a wealth of experience valuing and selling companies of different sizes and sectors. They understand the business landscape in the local area, have access to extensive databases of previous sales data and can work with your accountant to access the relevant financial information.
How do you value a business?
There are several business valuation methods you can use. An experienced business transfer agent will combine the most relevant methods from those we’ve described below.
Cost of entry
The cost of entry valuation method calculates how much it would cost to set up a similar business if you started it today.
It includes the startup costs, such as buying the tangible assets, hiring and training employees, developing the products and services and marketing the business. You should then think about where you could cut costs if you were to start again.
Cost of entry = project startup costs - projected savings
Although this approach can be useful for new businesses, it doesn’t account for its current financial performance or potential future revenues.
Asset-based
If your business has valuable tangible and intangible assets, you can calculate the net book value of your business. To do that, simply add the value of your assets, accounting for factors like appreciation, depreciation and inflation, and deduct your business’s liabilities, such as debt and outstanding credit.
Net book value = tangible + intangible assets - liabilities
Asset valuations often lead to relatively low business values as there’s no consideration for the business’s future financial performance or goodwill.
Comparable analysis
A simple but effective way to value a business is to compare it to other firms in the same industry and of a similar size that have sold recently in the area. You can use metrics like customer volume, business turnover and asset values as a reference point. You can then adjust the price to account for additional features or performance.
Business brokers have a wealth of information about previous business sales to provide an excellent basis for this valuation method.
Income-based
This is a common valuation method for early-stage companies with a stable income but that lack sufficient data to use other earnings-based methods. You just multiply the business’s annual revenue by a capitalisation rate, which is an industry-specific multiplier that accounts for risk and growth factors in the industry.
Income-based valuation = revenue x capitalisation rate
That capitalisation rate is typically a figure between 0.5 and 2. It provides a value based on the business’s earnings. However, it’s not always reliable as there’s no consideration for the company’s profitability.
A multiple of profits
If a business has a solid record of profitability, one tried and tested valuation method is to multiply the annual profit by a typical figure of between three and five, depending on the industry. You should ‘normalise’ the profits first, which you can do by calculating the average for the last three years.
Can I value my own business?
You can certainly get a ballpark figure by using one or more of the valuation methods we’ve described. However, given the risks associated with under- or over-valuing your business, we’d always advise you to seek professional help.
At Eddisons, we provide trusted and reliable valuations for commercial transactions, corporate reporting, lending decisions and more. With in-depth knowledge of the market and extensive comparable data, we create valuations in line with RICS professional standards. Find out more about our business valuations or request a valuation from our team.
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