The first step to selling your business is setting a fair asking price. So, one of the first questions on your mind will be: “how do I know what my business is worth?” This is something you’ll need to establish early, before you begin negotiations.
A business valuation is a calculation of the worth of a company. This may be based on several factors including annual profits, assets and growth potential. Intangible factors, such as your company’s reputation, can also play a part.
In this guide, we’ll explain how business valuations work and the various methods that can be used. We’ll also discuss how you can get your business valued professionally.
How Do You Value a Business?
Eventually, almost every business owner will find themselves wondering “how much is my business worth?” There could be many reasons for this – for example, to secure an investment or buy out a business partner. The most common motivation for getting a business valued is because you’re planning to sell.
To set a fair asking price, you’ll need an accurate idea of how much your business is worth. This will ensure you’re not selling for too little (leaving money on the table) or too much (deterring potential buyers).
So: how is a business valued? Here are some of the most commonly used methods of valuing a business.
Price to Earnings Ratio
The price to earnings (P/E) ratio, or ‘multiples of profit’, is a common business valuation formula. If you’re wondering how to value a business quickly, this is one of the simplest methods. It’s most suitable for established companies with a history of consistent earnings.
For example, a business with a P/E ratio of four would be worth £4 for every £1 of annual net profit. So, if the company made £200,000 after tax, it would be valued at £800,000.
Most businesses have a P/E ratio of between 4 and 10. P/E ratios for large companies, and those in fast-growing industries (such as IT), tend to be highest. A business acquisitions expert can help determine an appropriate P/E ratio for your company.
One of the most popular business valuation methods involves valuing the company’s assets. This is usually used for businesses whose underlying value lies in physical assets (e.g. manufacturing).
Calculating an asset valuation starts with determining the company’s ‘book value’. This is based on the total worth of its tangible assets, minus any liabilities (e.g. debts). Examples of tangible assets include:
- Property and land
- Equipment and machinery
- Inventory or stock
Next, you’ll need to determine the worth of any intangible assets (e.g. intellectual property). Combine this with the book value for a complete asset valuation.
Another way to value a business is to calculate the ‘entry cost’. This represents the amount of money it would take to replace the business – i.e. to build it up from scratch. It is calculated by determining the value of:
- All tangible and intangible assets
- Start-up expenses
- Product research and development
- Recruiting and training employees
- Deals with other businesses e.g. suppliers
This method of valuation may suit businesses with high start-up costs or those whose value is based on things like long-term contracts.
This approach to business valuation is based on the principle that a business is worth the sum of all its future cashflows – i.e. the money it’s expected to generate over time.
These are then ‘discounted’ at an appropriate rate (usually the weighted average cost of capital) to account for the time value of money, as well as potential risk. This results in a present-day value for the business. The rate typically falls anywhere between 15 and 25 percent.
Because it relies on predicting the future, this method is most suitable for long-established businesses with stable cashflows, such as insurance companies.
What Else Can Impact the Value of a Business?
Most business valuations are based largely around assets, cash flow and revenue. However, there are many other important factors that can also have an impact. For example:
- The size, age and location of the business
- The industry it operates in
- Competitive landscape
- Brand equity and reputation
- Goodwill (relationships with customers and suppliers)
- Employee morale and retention rate
It’s also worth noting that the value of a business is not always perfectly reflected in its sale price. Why and when you sell (e.g. the economic climate) can affect how much buyers are willing to pay.
Who Is Qualified to Value a Business?
Anyone can estimate the value of a business. However, if you’re planning to sell, it’s important to seek a valuation from a qualified professional. Not only will this give you a more accurate figure, but it will also help to speed up negotiations with buyers.
Your two main options are to speak to a chartered accountant or a business broker. Business brokers are experts in buying and selling businesses, and will often work with a team of financial and legal professionals to come up with an accurate valuation.
If you’re wondering “what is my business worth?” Chelsea Corporate can help. With years of experience in off-market sales and acquisitions, we know exactly how to value a business, UK-wide.
Selling Your Business? Contact Chelsea Corporate Today
Thinking of selling your business? If so, get in touch with off-market M&A experts Chelsea Corporate. We have a long list of clients looking to acquire successful, UK-based businesses like yours. Simply provide your details and we’ll let you know when we’ve matched you with an interested buyer.
Whatever industry you belong to, we guarantee a smooth, stress-free sales process from negotiations to closing. And as buy-side business brokers, we work for (and get paid by) the buyer – so you won’t have to pay any fees or commissions if you sell through us.