You’ve spent years, perhaps even decades, building your business, and now you’re ready to sell. But what’s it worth? And is it an attractive buy? Here we detail six business valuation methods and some of the features that make it a more desirable purchase.
What makes your business enticing to buy?
Even though you may have spent a lot of time and energy growing your company, specific features make a business more enticing to buy. These include:
Location. Where your business is situated could have a significant impact on its worth.
A solid financial situation, including enviable cash flow, an excellent financial history, and high-quality assets, like plant, manufacturing equipment, or property.
Reliable and repeatable systems. From your business management processes, accounting systems to your production operations, a business should be able to undergo a change in ownership without interruption. A strong management team that can operate without you adds considerable value to your business.
A good spread of happy customers with revenue not dependent on one single client.
An original or unique selling point: your brand, products, or even how you approach business.
How much is your business worth?
Beyond knowing how much your business is worth for the purpose of selling it, knowing its value also gives you an excellent overview of its health. And, if you know how to work out how much a business is worth, you can also improve its value. So, what methods can you use to estimate the market value of your company? Six are outlined below. A single method or an average of several will be used to find a sale price.
1. Return on Investment Valuation.
If you want a quick and simple valuation method, then this is it. Calculated as:
return on investment / amount invested
return on investment (ROI) valuation is a great tool to compare different businesses rapidly. But, it’s only a rough estimate, and there are many aspects of business ownership not taken into account. For example, any debts you might be taking on, business efficiency, or potential business growth. So, if you’re really interested in selling, look a little deeper.
2. EBITDA Multiple Valuation.
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization and is a metric used to evaluate a company’s operating performance. It can be seen as a proxy for cash flow from the entire company’s operations. For a more detailed look at how profitable a business is, the EBITDA multiple valuation is a good starting point. Depreciation is, of course, the loss in value of an asset over time, and amortisation is the gradual repayment of an asset or loan. The EBITDA multiple valuation can give you a deeper look into a business’s cash flow than ROI valuation.
The EBITDA metric is a variation of operating income (EBIT) that excludes non-operating expenses and certain non-cash expenses. The purpose of these deductions is to remove the factors that business owners have discretion over, such as debt financing, capital structure, methods of depreciation, and taxes (to some extent). It can be used to showcase a firm’s financial performance without accounting for its capital structure. Here’s an example.
To calculate EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
Although EBITDA doesn’t give the details of any debts, tax payable, or interest, it does give you an overview of a business’s earnings.
3. Revenue Multiple Valuation.
The EV/Revenue Multiple is a ratio that compares the total valuation of a firm’s operations (enterprise value) to the amount of sales generated in a specified period (revenue). Generally, the EV/Revenue multiple is used for companies with negative or limited profitability.
Revenue Multiple = EV / R
Enterprise Value (EV): The total valuation of the firm’s operating assets and liabilities.
Revenue: The annual sales of a company, which are most commonly expressed over the last twelve months.
The lower the revenue multiple, the better the investment, meaning potential buyers are more likely to be interested. By using revenue, you’re comparing the enterprise value to income from trade without considering any outgoings.
4. Simple Cash Payback Valuation.
Simple cash payback valuation is a simple method to work out how fast your purchaser will regain the value of their investment. A lower value is by far more preferable as it will take a buyer less time to make their money back.
Cash payback = business price / net cash inflow
This is the time it takes to regain money spent, not generate more. So as a seller, you either need a low value for your business or a buyer that isn’t looking for short-term gains.
5. Balance Sheet Valuation.
If you are selling a company with a large number of physical assets, for example, plant, equipment, or even property, a balance sheet valuation may be useful. A company’s balance sheet will show its profits, expose the value of all physical property, and outline its debts and financial obligations, too. If someone is investing, they’ll want to know everything about what they’re taking on.
However, a balance sheet valuation doesn’t alert potential buyers to internal operational problems or inefficiencies. Neither does it show future possibilities.
6. Discounted Cash Flow Valuation.
Discounted cash flow (DCF) is a valuation method used to estimate the value of an investment based on its expected future cash flows. Discounted cash flow uses future cash flow estimates at present value to work out whether an investment will bring positive returns. The higher the discounted cash flow value, the better the investment potential. The formula for calculating discounted cash flow is as follows.
Discounted cash flow = cash flow(year 1) + cash flow(year 2) + cash flow(year 3)
(1 + discount rate1) (1 + discount rate2) (1 + discount rate3)
The purpose of DCF analysis is to estimate the money an investor would receive from an investment, adjusted for the time value of money. The time value of money assumes that a dollar/pound/Euro today is worth more than a dollar tomorrow because it can be invested. As such, a DCF analysis is appropriate in any situation wherein a person is paying money in the present with expectations of receiving more money in the future.
You may expect different cash flows year on year, and you can use different discount rates each year, too. Comparing the total value of discounted cash flows to the purchase price of your business today will tell a buyer whether purchasing your company is worth it. Just make sure that the discount rate that you use is accurate.
As you might expect, discounted cash flow relies on predictions; what you expect your cash flow to be. Unfortunately, not all forecasts are accurate, potentially leaving your business valuation flawed.
What’s your business worth to you?
Whilst all of the above methods are used commonly by business brokers and experienced business buyers, and as a rule, the business owner who is selling doesn’t get to choose which method an acquirer will use. Perhaps the hardest question is what is your business worth to you as a business owner. This may have little bearing as to its market value.
There are many benefits to owning a business, some of which are intangible, for example, the feeling of pride that comes with seeing a job well done that your business has performed. From a practical standpoint, for a lot of small business owners, the compensation they receive from their business (e.g. wages plus dividends, plus healthcare, plus other intangibles such as mobile phones, etc) needs to reflect the value they will receive on selling. This is why there is often a gap between what a business owner feels their business is worth and what a potential acquirer values it at.
What else should you think about when selling your business?
The first thing a potential acquirer will be looking for is whether the business can be managed without the current business owner’s input. If the business is completely centered around the business owner then removing them adds an element of complexity that detracts from the value of the business. The new owner will either have to manage the business themselves or employ a professional manager to run it on their behalf.
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Selling a business doesn’t need to be complex, but you do need the right advice. Besides the monetary value of your company, there are a few other things you should consider.
You might not be able to sell up immediately, and you may have to wait for the right market. In the meantime, your accountant can undertake cash flow modeling to ensure that, after the sale, you have the income to enjoy life after work. After all, you want to enjoy your wealth!
Get some tax advice in the run-up to the sale, too. It’s best to ensure that the transaction is tax-efficient before the deal goes through rather than receiving a large bill afterwards! And speak to an estate planner. They’ll help you determine what will happen to your money and how your estate will be divided upon your death.
Are you ready to sell your business but don’t think your accountant is giving you the right advice? Get in touch. We can determine how much your business is worth and suggest improvements to make it more valuable and help you get the best price for it. Call us on 01482 408585, email us, or book an appointment and visit us at 277 Anlaby Rd, Hull HU3 2SE.