What is your business worth? Valuing a company is something you’ll want to do when selling it or merging with another, when raising business capital, or raising finance to make an acquisition of your own. Over-valuing your business can put off buyers or investors, but under-valuing it will sell you and your shareholders short. So the key is to find the right balance.
In this guide, we run through how to value a company using some commonly used frameworks.
How to value a company
Valuing your limited company is a key part of trading shares, going after investment funding, or planning an exit strategy when it’s time to sell your business. When new horizons are in your sights, whether that’s taking your business to the next stage of growth or planning your own retirement, a lot is riding on the amount you’ll fetch for it.
Numerous factors are at play when it comes to business valuations. Financial factors, like future profitability and physical assets, are important, but so are other aspects like the current economic climate, your brand’s reputation, competitors and the reasons behind the sale. Combining all these aspects into one sum isn’t a simple task, but here are some popular approaches to get you started.
Value of net assets
This fairly simple calculation is based on your tangible assets, which include physical things like premises, land, machinery and stock. To work out the value based on your net assets, calculate your assets minus your liabilities. You’ll need to update your balance sheet for this calculation to factor in aspects like inflation and depreciation.
Although working out the value of your net assets is a good place to start, this figure doesn’t take into consideration other intangible assets like intellectual property, trademarks, patents and brand.
Discounted cash flow
Discounted cash flow aims to work out what the future cash flow would be worth today. It’s a complex formula based on the assumption that £1 today buys more than £1 tomorrow, because of inflation.
To calculate your business’s discounted cash flow, you add up the dividends forecast for the next 15 years or so, plus a residual value at the end of the period. Then, you apply a discount to work out what it would be worth today. The discount rate could be anything between 15 to 20 per cent.
Experienced investors may look for this figure, and it is said to be the valuation method of choice for Warren Buffett.
With entry cost, your aim is to show how much it would cost to build your business from the ground up. Consider costs including start-up fees, recruitment and training, tangible assets, development of products, marketing and more. Be prepared to discuss where savings could be made via streamlining etc.
Industry rule of thumb
Some industries have standard ways of calculating business valuations. For example, IT businesses are usually valued by turnover, whereas retail or food and beverage companies are valued based on the number of outlets. It’s a good idea to find out what’s considered standard for your industry, because you’re likely to be questioned about this figure.
This method, also known as multiples of profit, compares the price of your company shares versus your company earnings. Public companies calculate their price-to-earnings (P/E) ratio by dividing the price of stock by the earnings per share.
If you’re a private company, you can look at the financials of comparable public companies and apply their price-to-earnings ratio to your business. To do this, you simply multiply your profits by the ratio figure, which could be anything from two to 25. For example, if your net annual profits were £100,000 and comparable companies had an average P/E ratio of five, you would multiply the £100,000 by five to get the valuation of £500,000.
Deciding on the figure by which to multiply your profits is the difficult part, so it’s good to get business advice if you’re not confident with the stock market.
A valuation based on what can’t be measured
The financials of a business aren’t the only aspects that make it attractive to a buyer. An enviable location, a recognised and well-reputed brand, reliable customer and supplier relationships (‘goodwill’) and innovative patents can all make a business worth more to a prospective buyer.
It would be wrong to leave these aspects out of your business valuation if they would swing it in your favour, but putting an exact figure on these intangible assets is a specialist area. Your best bet is to seek independent business advice to get an objective and expert opinion on achieving the right offer when you sell your business.