Valuing my Business to Sell

How do I get an accurate business evaluation?

There are many ways of valuing a business, but the principal driver is the underlying profitability of the business. Provided that the business is trading at a reasonable profit level, the principal valuation will be based on a multiple of the profits.

However, there are many factors that will have a bearing. The market sector the business operates in is important. Some sectors like internet weighted operations command a higher rating, as do larger companies. The business cycle for the company has an impact. A lower price will be given for a ‘sunset’ company, i.e. one where the industry is in decline, than one where there continues to be growth potential. This can also apply to companies who have the major market share, the downward risk for an incoming acquirer can outweigh the upward potential. The overall economic view does not normally affect the value of the business, although at the start of recessions buyers may hibernate for a short while but activity quickly picks up.

Ultimately the valuation of a business will be what a buyer will pay for it. This can vary as a buyer will have identified the strategic fit and synergies they will gain on the acquisition and the art of the broker is to try and ensure some of that benefit is paid in the price of the business. This will depend on the purchasers willingness or concerns in losing the deal. It is seldom the case that we see in the smaller end of the mergers and acquisitions market the ego charged chief executives substantially overpaying on a purchase. That said, there is always hope, but it is best to be realistic.

Return on investments

For some businesses, particularly where there is little owner management involvement in the running of the business, a valuation based on the returns could be considered. Examples of this would include a buy for let portfolio. Here there is an annual income which is considered to be fairly constant and can be compared to other forms of investment. A valuation of this business will vary depending upon current interest rates and current returns on other types of investments, but thus if 12% is considered to be a reasonable return, bearing in mind the risk element, then the overall value would be 8 times the return. Again there may be underlying assets which if higher than this value would give rise to a valuation increase provided they were likely to keep their value or increase over time.

Net asset valuation

For those companies with very high net assets or loss making business, a valuation can be prepared purely on the likely realisation of those net assets after costs. This value could be adjusted upwards by any potential in turning the business round.

Multiple of profits

In publicly quoted companies, it is common to see a P.E. ratio quoted. In simplistic terms, this is the number of years earnings after tax that the price represents based on its last full years reported profits. A valuation of a private company will look at the profits for the year before tax after adding back owner and director costs, but then taking off an estimated managerial cost for the work that is carried out by the owner managers who are unlikely to be around some months after the sale. The value of the business is then a multiple of this, which varies depending upon the size of the company, the market segment that it operates in, and the general outlook on future prospects of the company. Smaller companies have lower ratios and can easily be as low as 3 times. For larger companies with prospects in an interesting market sector can be at 7 times. Other factors will also need to be taken into account as there may be surplus assets within the company. These can include surplus cash resources, and freehold property. Adjustments to the value need to reflect the benefit of these assets. There might also be undisclosed liabilities. An example of this would be the redundancy costs if an acquirer was seeking to relocate the operations away from the area. Having calculated a value, it might be due to the low profits, the value falls short of the net assets within the business (negative goodwill). This may nevertheless still be the correct value but other valuation methods would need to be considered.