In many cases there can be more than one answer. If you are buying a business, the question should probably be how much is this business worth to me? What is the earnings potential? What is the return on investment? Business valuation is an art, not a science; it is subject to the assessor’s judgement, skill and methodology.
There are several standards of value.
- Fair Market value – How much a business would sell for in a transaction between a motivated buyer and seller. Both parties have a good understanding of relevant facts. Neither party has an urgent need to buy or sell.
- Investment or Strategic value – The value to a specific buyer. The purchase is probably part of a strategic plan. Perhaps part of a buy and build plan.
- Fair value – Legal standards which may be used, for example, in a divorce case.
- Intrinsic value – Fundamental value of stocks worth.
For most valuations, we are probably going to talk about fair market value. What would a buyer pay in the open market?
Three different approaches are typically used when valuing a company.
- The asset approach – Values the business assets less any liabilities. (Net Asset Value) The balance sheet will used as the basis for the calculation. The valuer will typically check balance sheet data and use other data to confirm values. E.g. a RICS valuation for fixed assets, age of any debtors and potential stock obsolescence. This approach is normally used for a stressed or distressed business.
- Market approach – What is the market typically paying for a business. You will review a number of like companies in similar sectors. There are a number of databases which can be used to compare multiples of sales or earnings. This method is normally reliable and is a good indicator of business value.
- Income Approach – the present value of the income stream that the business will bring to an investor. There is a number of capitalisation methods employed and other complex methods such as discounted cash flow.
Any valuation is a guide; simply put what is a buyer prepared to pay for it. We will try and gather all of the data we can and use different methods to compare values.
Valuation of a Small Business
A Small business is relatively straightforward to value. It will be based around the Net Asset Valuation method considering Goodwill. The Goodwill of the business will be derived from the true business profitability.
To identify the true level of profitability, you should adjust for any one-off costs and owner benefits, and replace any owner benefits with a manager’s salary at current market rates. Once you are happy with the true profitability of the business, (it’s often a good idea to calculate as a three to five-year average) you can calculate the goodwill amount. You would normally multiply the net profit before tax by a multiplier of between 2 and 3.
The value of a business will be based upon many factors, some of which we have listed below. In simple terms if we can achieve a fair market value along with a price that is affordable to a buyer, and we can effectively demonstrate a positive return on investment, we will be well placed to effectively sell the business.
Key factors that may influence price:
- Asset value – make sure there is a clear basis for the valuation. Compare the key aspects of your fixed assets to the current market value.
- Number of years trading
- Business History
- Strong, healthy cashflow
- Strong management team in place
- Intangible assets such as IP and Good Will
- Property value
- Industrial sector
- Customer contracts
- Recognised brand
Be as accurate as you can when valuing a business. Be realistic and always try and consider the valuation from the buyer side. Consider the industry sector. As a rule of thumb, for a small business the price to earnings ratio may be up to 50% lower than a similar company listed on a recognised stock exchange.
Contact West Midlands Business Advisors
Whether you are looking to buy a business, or sell your business, we are here to help. To discuss business valuation, or to book your free consultation, simply call 0121 769 0272 or email email@example.com.