Thinking of Valuing Your Business?
You might be thinking of selling your business or simply planning for its future. No matter what your circumstance is, getting an accurate valuation should be a priority in your business journey. Your business will have unique characteristics, so it needs to be valued using appropriate methods and tools. This will ensure you find the best buyer and receive a fair financial reward for investing years of time and resources.
This guide examines reasons to value businesses, the variables and techniques that generate valuations, different valuation methods, and a few sector-specific valuation examples. We'll let you know what the benefits of valuing your business are, what you can expect, and the professional support you may need.
Whether you are a limited company, a private company, a public company, or any other type of business, finding out more about valuing a business should be on the top of your to-do list.
What is a Business Valuation and Why Should You Consider It?
In essence, the purpose of a business valuation is to paint an accurate picture of your business's worth. Valuations consider some combination of the market value of assets, current and/or projected revenues and/or cash flow and other barometers of your business's health. Getting an accurate valuation will give you granular insights into its functionality and financial value.
Possible reasons for valuing a business:
- You want to know your business's value before selling it
- You want to gain a better understanding of your business so you can have practical expectations for the selling or buying process
- You want to find where the strengths and weaknesses lie
- You want to identify areas that need improvement
- You want to determine if its success is sustainable
Benefits of valuing a business
- Setting a credible asking price before selling the business
- Providing information that reassures buyers and reveals ways they can build further value
- To inform an exit strategy for growing, improving and eventually selling the business
- Securing capital investment from investors
- Setting the price of shares for purchase by employees
Criteria that Affect a Business Valuation
There will be different criteria that affect the value of a business, and they will vary in importance. These can range from your fair market value of tangible assets and your historical financial performance. Here are some basic factors you will need to consider when valuing your business:
- The circumstance of the valuation: this may be a voluntary or forced sale. This can impact the valuation and power dynamic during negotiations
- The value of your tangible assets: this can include cash, premises, land, machinery, furniture, stock, equipment and employees
- The value of your intangible assets: valuations can account for historic and projected profits, revenues and cashflow. Projections are estimated based on your intangible assets such as the business's age, goodwill, intellectual property, and the business's core values and culture
- The durability of these assets and wider economic conditions or external influences. For example, a gloomy economic outlook would not undermine the appeal of a recession-resilient business like a pawnbroker or convenience store. And a business whose revenues have been growing steadily over many years will offer the stability that is much prized by buyers.
Considering these areas will help you manage the risk profile of your business. It will also provide a comprehensive outline of your business's worth to potential buyers.
If your business has grown significantly, you may be looking to bring in a partner. In that case, you will need to have a clear understanding of your equity and share value. Whether you are considering a loan from a bank, looking for potential buyers, or mapping out plans for your business, considering these factors will illustrate where your business is and how it can grow.
Business Valuation Techniques
Naturally, how you value a small business (like a café) would differ from how you value Amazon, Apple or Accenture. Most business valuations consider the value of physical assets and income and often draw on multiple valuation techniques. We briefly cover these in our selling guide, but we will discuss them in more depth here.
The Asset Approach
This approach is effective for businesses that are asset-rich, like a property investment firm or manufacturers. Used alone, it is also useful for businesses in liquidation. The asset valuation method establishes the ‘net book value' (NBV) – or net asset value – by subtracting the total value of liabilities from the total value of business assets recorded on the balance sheet.
The resulting figure is then adjusted for factors such as changes in asset values, bad debt and ageing stock that must be sold at a discount. Keep in mind though; this approach does not consider future earnings or goodwill.
Seller's Discretionary Earnings
If you have a small or middle-market business, this method would be suitable. The SDE method considers your total cash flow including discretionary items like salaries, benefits, and depreciation. Remember to include your expenses in this method, like your rent and labor.
This method gives you a strong reflection of your business's profit potential by calculating what the business's earning would be with the buyer.
Price-to-Earnings Ratio (P/E ratio)and EBITDA
The price-to-earnings (or P/E) ratio method establishes the value of a company's earnings per share. Used to determine whether a limited company's stock price is overvalued or undervalued, it usually only applies to companies listed on the stock market.
Determining the most accurate number for your P/E ratio depends on your type of business. It is a good idea to compare your business's P/E ratio with others to find their relative value.
The acronym EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation. A company valuation based on EBITDA will look at the net earnings before any other facts are considered. Remember that this method ignores many factors that could impact the profitability of your business.
Entry Cost Evaluation
Entry cost valuation predicts what it might cost, approximately, to establish the business from scratch, including the cost of fitting out premises, employing and training staff, developing products and services, and establishing a customer base and reputation.
The hypothetical business must be built as cost-effectively as possible, for instance by locating premises in a less expensive area if this wouldn't credibly weaken profitability.
Discounted Cash Flow
The discounted cash flow method calculates the present value of projected cash flows. A discount interest rate – typically around 15%-25% – is applied to account for the ‘time value of money', whereby cash becomes more valuable over time due to its income-generating potential.
Based on long-term assumptions, this income-based approach is typically used by the largest companies with long, consistent trading histories such as banks, utilities and energy companies.
This relatively basic method calculates a figure based on valuations of similar businesses – in terms such as size, sector and location – that are available in the public domain.
How Can I Secure a Realistic Valuation?
You can maximize your business valuation and eventual sale price by improving the business beforehand. You can do this by using appropriate valuation techniques and being strategic about how you market your business and negotiate a deal.
You can build value by strategically planning for your exit ahead of an eventual sale. A business plan provides and invaluable framework for building a top valued business and impressing investors or buyers with a clear vision.
This plan, which should evolve over time, can help you build your business's strengths and mitigate any weaknesses.
Negotiation skills - confidence is key
Sellers, or their intermediaries, must be able to explain to prospective buyers how the asking price was arrived at and why the assumptions underpinning the valuation – such as profit multiples or the value ascribed to goodwill – are sound.
It will help to convince them that the business is worth investing in, and that they have the skillset and experience required to generate a solid return on their investment and perhaps take the business to new heights.
Seek professional advice
An external expert can offer an impartial, well informed valuation that lends intrinsic credibility to the asking price, and more than justifies the business valuation cost through a quicker or more lucrative sale. When finding someone to assist you with a valuation, make sure you are looking for appropriate expertise. You will need to find someone who has knowledge and experience in valuing businesses that are like yours.
The size and sector of your business and the type of product or service you offer can affect the way that it is valued. You can receive an accurate, fair market value if you find someone who has successfully valued a similar-sized business.
While there are similarities that run through all valuation processes, each sector will have different circumstances. To illustrate the valuation process in practice, we offer some examples of different sectors below.
How to value a petrol station
Petrol station values are typically appraised using one of three valuation methods.
The income-based approach, which best suits gas stations with a long trading history of reliable earnings growth, is calculated by dividing a one-year cash flow projection by the market capitalization (or market cap) rate.
The market-based technique, meanwhile, arrives at a valuation based on the going rate for similar private businesses and comparable share values.
Finally, discounted cash flow, based on the current value of free cash flow available over the life of the business, can be credibly used by both long established, low growth businesses and high growth, market entrants.
How to value a retail business
You may have a small, one-person operation or a large retail space with several employees. Regardless of your context, you will need to have clear, detailed records of your business in the years leading up to your valuation. Ensure you have records of your percentage of sales, the value of real estate or lease duration, fixtures and stocks.
You should also compare your business to similar ones to see how it fairs with them. Comparing your business to others will give you a holistic understanding of the fair market value.
How to value professional service firms
Professional service firms – broadly defined as knowledge-based businesses such as legal, consultancy, and accountancy firms – are light on tangible assets and vulnerable to changing circumstances that weaken their intangible assets.
As such valuations are often based on projected earnings generated from historic trading performance, stellar reputation, intellectual property, products and services.
Much value also lies in the personal relationships between owner and clients.
Valuing Your Business with the ValueRight Online Tool
ValueRight is a free BusinessesForSale.com self-service valuation tool. To get all the benefits of the tool, ensure you provide as much information as possible when you begin the valuation. The process is relatively simple, and you can get an objective valuation.
An advantage of using this tool is that your business will be compared to 20 years of BusinessesforSale.com data that will correctly benchmark and value your business. Inputting all your information into ValueRight will only take you around 45 minutes and all your information will be stored securely.
Before you start your valuation, remember to have access to at least a year's profit and loss statements. If you can, three years of statements will offer a more concise picture of your business and therefore, a better valuation.
The ValueRight service is free, and you can access it here. Once you have put in all the necessary information, you will be given a downloadable PDF report that you can keep, show to potential buyers or professionals who can evaluate the results. This document will be your business valuation report.
For more information, you can contact the support team.
Do You Still Need an Accountant?
You can, of course, go to an expert to get a valuation of your business. It is vital that you find the right person who has the right experience. You should find out what experience and credentials any accountant has before getting them to value your business.
Although accountants can value a business, valuation agents can do the same. They can appear in various sectors like business brokers, lawyers, and chartered surveyors.
If you are concerned about financial obligations, ValueRight can give you an accurate valuation and you can proceed and list your business at a price that is fair and attractive to potential buyers. As we said before, this is a suitable, safe, and effective option if you are concerned about the cost of a business valuation.
Using ValueRight before approaching a professional will provide you with useful knowledge. Being as informed as possible will allow you to stay on top of anyone you hire and will take any uncertainty out of the process.
You will, therefore, already have an estimate of your enterprise value and you can be sure that the person you hired is doing it correctly.
Our Rule of Thumb
With over 20 years of knowledge, BusinessesForSale.com understands the importance of valuing a business correctly. Thousands of businesses have been sold through our website, giving us insights into what buyers look for in a business and the most effective ways to advertise a business for sale.
Step 1: Plan ahead
The first important step to a satisfactory business valuation begins long before you enlist the business for sale. If you have an idea of when you want to exit the business, start to improve areas of your business that need attention so you can maximize its appeal. This will likely get you a better valuation before you sell.
Step 2: Prepare the business
There are a few ways you can prepare your business for a better valuation, and these will vary depending on the type of business you have. You may need to boost sales, build better goodwill, reduce operating costs or protect the business from long-term threats.
You could also improve the business by updating your training procedures or upgrading your software. Even the most basic improvements will improve your valuation. Ensure you get your paperwork in order and payments up to date. Identify if there are any areas that need to be updated, like record keeping.
Step 3: Get an accurate valuation
Finding a buyer hinges on getting a realistic, independent business valuation, along with careful preparation, effective advertising and perceptive negotiation.
Achieving this will be challenging without professional help, so it's worth checking out our services directory to find business brokers, accountants, lawyers and other business advisers.
The Last Step: Good Listing Increases Business Value
Make sure you do not undermine all your hard work by getting your marketing wrong. The best starting point is to list your business on a platform that will successfully market it to potential buyers. This advert needs to be well drafted and distributed to ensure the widest possible exposure.
Adverts should prominently flag features that will appeal to buyers: a high footfall trading location; low rent or an easily transferable lease; a long track record of healthy, growing profits; unique and patented products; and availability of seller financing or owner willingness to stay on post-sale.
BusinessesForSale.com is the biggest market for business sales, connecting more than a million business buyers and sellers each month. List your business with us to make sure you are visible to buyers in Australia and beyond.
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