Thinking of selling or buying a business, or raising equity investment? While you may have a number in mind, you will be asking yourself ‘how do I value a business and how much is the business actually worth’? The flippant answer would be ‘What somebody is prepared to pay for it’, but how does the buyer decide how much to offer?
There are many techniques used for valuing a business, ranging from simple methodologies like asset value and EBITDA (Earnings before Interest, Tax, Depreciation and Amortisation) multiple to complex discounted cash flow calculations. Ultimately all have the same aim - to put a value on the on the business that reflects its worth, and which it is expected to produce via future cash flow.
Note that valuation is not an exact science. There are a number of factors that can affect it, such as market sentiment, consistency of profits, customer/supplier concentration, balance sheet and the management team, to name but a few.
So, how then do you work out what your business is worth?
Firstly, you need to consider what the buyer/investor is interested in. Are they buying just the assets of the business, or all the 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 that 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.
The most commonly used valuations involve a multiple being applied to a company statistic - usually the company’s profits, or sometimes its sales, or 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 and company size - picking the right companies for comparison is very important. Remember, multiples for listed businesses will vary significantly to those for private companies because there is no open market for the shares.
Generally, the multiples are applied to actual historic results for, say, the last financial year or further back. Occasionally, they may be applied to forecast figures, particularly if the figures are supported by secured contracts. So if you are thinking of selling your business, both good historic information (audited accounts or comprehensive management accounts) and reliable forecasts are important.
Typically this number will then be adjusted for any excess assets (such as any assets over and above what is used to generate profits, like surplus cash) and structural debt (such as bank funding which will be repaid at the point where the deal completes).
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. An advisor can help in determining a range of valuations and support in your negotiations.
For tech start-ups, valuation can be more challenging than for an established company and may require a different approach. To read some tips and commonly used start-up valuation methods, check out our blog post, How to value a tech start-up.