How to value a business

Valuing a business can be a useful exercise for a number of reasons. As well as being essential during the buying or selling process, having a valuation can help you secure a loan or investment, set a share price, assess the financial health of your business or help in succession planning.

Areas to look at when valuing a business

Businesses have both tangible and intangible assets. Tangible assets such as stock, premises and machinery are relatively straightforward to value.

Intangible assets are harder to assess. These include the reputation of the business, its age, the strength of the customer base, whether a sound team is in place and the business’s intellectual property such as its brand and trademarks.

Other circumstances will also affect value, such as the state of the market, whether the sale is voluntary or not and the age of the business. A start-up may not be profitable but could have high growth potential, while an established business may be on a more predictable trajectory.

Business valuation methods

There are a number of ways of valuing a business and each sector tends to have its favoured methods.

Asset valuation

This method is suited to businesses with substantial tangible assets. Both tangible and intangible assets are valued and the amount of any liabilities such as debts and credit is subtracted to provide a net book value of the business.

Valuing a business in this way does not take into account goodwill, ie. the amount that buyers might be prepared to pay for the company.

Entry cost

Entry cost valuation looks at how much it would cost to set up a similar business from scratch. This would include buying assets, setting up the business’s legal framework, taking on and training staff, marketing and developing the business to the point the existing organisation is.

Comparable analysis

If other similar businesses have been sold recently, then an easy valuation is to carry out a comparison. Make sure that the other businesses really are comparable, or make adjustments for any obvious differences, such as premises in a more expensive area or a bigger market share.

Price to earnings ratio

An established business can be valued by looking at the profits a business is making each year and multiplying them on the basis of their potential in the future. For example, a start-up with the likelihood of good and rapid growth would have a higher multiplier than a stable, steady business with no plans to expand.

The annual profit, adjusted to include any upcoming events such as extra costs or investment, known as the normalised profit, would normally be multiplied by a figure between three and five, depending on the anticipated trajectory of the business. For a business with huge potential, the figure could be substantially higher, as is often seen in the tech start-up sector.

Discounted cash flow

Discounted cash flow valuation is a more difficult way to value a business and is suitable for mature and stable businesses. It values estimated future cash flow and dividends over the next fifteen years or so, with the residual value that is anticipated to be there at the end of that period also added in.

This is a complex method of valuation and generally only used for large organisations.

In summary

Valuing a business can be complicated and the actual achievable price will depend on what potential buyers are prepared to pay, and so may skew the value in either direction.

If you are thinking of selling your business, there are steps you can take to both prepare it for sale and to make it more attractive to buyers. For more information, see our article How to get the best price for your business.

Contact Us

At Quinn Legal we have extensive company and commercial knowledge. If you are considering either buying or selling a business, our expert team can offer advice and guidance as well as negotiate on your behalf and prepare the necessary documentation.

For a no obligation initial consultation or to make an initial free enquiry, please call our team on 01624 665522, email us at email us: hello@quinnlegal.im or fill in our online enquiry form.