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How do you value a business?

How to value a business?

Thinking of selling or buying a business? While you may have a number in mind you will be asking yourself how do I value a business and how much the business is actually worth? ‘What somebody is prepared to pay for it’ would be the flippant answer, but how does the buyer decide how much to offer?

There are many techniques used for valuing a businesses. Ranging from simple multiples to complex discounted cash-flow calculations, but all ultimately have the same aim - to put a value on the future cash-flow that a business is expected to produce.

If you already know how much cash will be produced, valuation is relatively easy.  However, you need to know precisely when the cash will be produced - a pound today is worth more than a pound in the future due to inflation. uncertainty. In the real world the ‘how much’ and ’when’ is not that straightforward to work out. Valuation is not an exact science.

So, how then do you work out what your business is worth?

You need to consider what someone is buying.  For example, are they buying the assets of the business, or shares in a company?  Are they buying the whole business, or just a part? Are they inheriting the cash or debt in the business or is it being sold on a cash- and debt-free basis?  Are there any land and buildings, or valuable intellectual property, which will be included in the sale?  Are there any tax implications? What is the normal working capital that the business requires in order to operate properly? And how is this all to be funded? 

With all of these things to take into consideration, where do you start?  Taking professional advice from an accountancy or corporate finance firm is one option, as they would be able to guide you through the process.

For a quick estimate, though, the simplest company valuations involve a multiple being applied to a company statistic - such as the company’s profits, or its sales, or sometimes an industry-specific measure such as room occupancy for a hotel. 

Working out the correct multiple to use is then the next trick - the usual way of doing this is to look at prices paid for similar businesses in the past or to look at the valuations of similar businesses quoted on the stock market. 

These can vary widely by sector, from low single digits for mature, low-growth businesses to multiples of 20 times, 30 times or higher for high-growth technology stocks. Valuations can also vary widely with company size - picking the right companies for comparison is very important. 

These multiples are often applied to actual historic results for, say, the last financial year, but equally may be applied to forecast figures.  So if you are thinking of selling your business both good historic information (audited accounts or comprehensive management accounts) and reliable forecasts are important.

The important thing to remember, though, is that ultimately there is no such thing as a correct value for a business, only a range of values that are acceptable to both the buyer and the seller.

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