How to value a business
Updated: Feb 1, 2020
In this blog we discuss business valuation, market price and sale price.
A company valuation differs according to approach, industry and an investor type.
A bank or other financial institution will largely value a business on its assets and give little if any credit for goodwill, as it will want to look at worse case scenarios when lending money. Also, hedge funds and private investors may have a similar approach.
An entrepreneur will try and view any business from the point of view of future profits and will take into account the past financial performance and anticipated future profits.
A corporate acquirer will not only look at the past profits but also client base, product, personnel and will want to understand the impact on their business of any acquisition. Many acquisitions are strategic decisions to diversify, offer more choice and create a larger following for their products or services. There is also an industry by industry approach where past deals are carefully scrutinised and used as precedents and comparable.
So in summary, any company is only worth the price offered for it. However, there has to be a starting point that is credible, realistic and yet creates the best price for the vendor.
A sensible approach is to establish a true figure for profitability over the previous 3 years. This gives a good indicator of where the business is heading. After establishing an EBITDA (Earnings Before Interest Taxation Depreciation and Amortisation) any other one off costs for that year need to be added back as profit. This could include investment in website, IT, consultancy costs, repairs and maintenance, acquisitions, property costs, and new machinery and equipment. These are decisions on profit rather than costs which have directly produced turnover. Any loan repayments also need to be treated as profit. Any other perks for Owners including personal motor and travel expenses, health and pension benefits, directors loan repayments also need to be treated as profit. Once the annual profit has been established, a multiple of between 3 and 5 can be used to create a guide value for goodwill, and this will depend on the industry and longevity of the business as well as carefully considering the company’s future predicted earnings. In different industries larger multiples may be relevant.
There are different theories for asset valuation and most astute buyers will argue that the value is as stated on the balance sheet. My past approach has been to have a current valuation done on all assets as even after depreciation allowances there is a value in the real world and a good example of this is property. Any stock would be valued at cost, so a market value would consist of the goodwill value plus assets.
A sale price may of course be different. Those that are selling their company over an agreed 3-5 year period (which is the case in almost all deals) may be paid in staggered payments which may be profit related, or they may receive payments through shares in larger acquiring companies. Of course salary/consultancy packages play a part in any decision.
A good business broker would be able to take you through the journey from market preparation to deal conclusion. Experience is key in getting the best deal.
Would you like to discuss the sale of your business?
Book your free consultation with the author of this post Zach Dogar.
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