Wondering How Much Your Business is Worth and How to Value it?

How much is your business worth?

One of the first questions business owners ask us when we first meet is, “How much is my business worth?”

Although what it is worth is one of the most important factors, at the end of the day, your business is worth what someone is willing to pay for it.

What we can help you with is creating a more valuable business in the eyes of a prospective buyer. Most businesses are based on a multiple of profits so let’s focus on improving those profits before you start a sales process.

You of course want the best value you can get and basing your expectations on a logical methodology based on the figures, is always the best approach and one that most buyers will take. However, the exact number you reach, and the number the buyer reaches will inevitably be different. Ultimately, the true value is what both you and the buyer deem acceptable, and it always comes down to negotiation.

How do I value my business?

Most business owners we meet, have never sold their business before and do not know where to start with valuing their business. There are several ways of deciding the value and it is our aim to show you these so we can come to a realistic valuation, rather than just giving you a number.

Before we dive into the exact methods, some of you may be asking well what exactly is a business valuation? To put it simply, it is an indication of what your business is worth. Usually this is in the context of what it is worth to an external buyer in the marketplace who is buying 100% of the shares of the business. So, you sell the business and the value is what you get paid for.

Business owners we speak to have often looked online at some of the calculators which give a valuation usually at the higher end of realistic and setting unrealistic expectations!

So, rather than skip to the end and just give you a number, we will show you how we calculate the value and talk about what you can expect as part of the process.

Dexterity Partners offer a Free Business Valuation mechanism which explains the “levers” to pull to maximise value. We undertake this with the aim of understanding exactly what your goals are and what you want to achieve so we can help you work towards this.

How do you calculate the value of a business?

No matter what approach you take, the business value is going to be derived from several factors including its size and profitability , its business model, the future potential and other factors that differentiate you from competitors.  

Is valuation based on turnover a good value indicator?

Many business owners come to us with the idea that turnover is important for the valuation, however this is generally not the case. Although turnover is important, the value normally comes down to profitability now and in the future.

There are some cases where turnover is important, e.g. in fast growing businesses experiencing exponential growth where increasing turnover is more important than profitability for now. But it is very rare that turnover is used as a valuation mechanism rather than profits, as at the end of the day a buyer is wanting to buy your business as it will make them money in the long term. Profitability is, at the end of the day, what makes the new owner money not turnover. As the saying goes  “turnover is vanity profit is sanity”

In some cases, turnover can have a small impact on the valuation, as a business with greater turnover usually has a greater ability to increase profit on a pure number’s basis, but if it does have an effect, it will on a base valuation reached by looking at the profitability.

We’ve explained the factors that go into a valuation but how do these come together to give an actual number?

The most common approach to valuation we see is using the following formula:

Normalised EBITDA x multiple (general + specific characteristics of your business) + free cash less debt. Adjusted for normalised working capital

What this essentially means is, the valuation is equal to the profit of the business multiplied by a number (called the multiple – we will come onto this) and add the cash in the business to the value but subtract any debt.

So, let’s go through each of these factors in more detail.

• Normalised EBITDA – this means Earnings before Interest, Tax, Depreciation and Amortisation. Hence the EBITDA acronym. So, take the profit you made, add back in those 4 elements and you have the EBITDA. The normalised part basically means you adjust for any exceptional items. In practice this usually means any costs that are in the business.
• Multiple – This what you times the EBITDA by. Usually in the 3-7 range but it varies for every deal, with larger businesses usually having  a greater multiple than  smaller businesses. This is effectively the point of negotiation in most deals where the level of profitability is fixed and what the buyer and seller each believe the multiple should be is where the valuation differences come from. In the end this comes down to negotiation between both parties.
• Free cash – This simply means the cash in the business and the free part is just to say what cash is not needed in running the business day to day.
• Debt – If you owe money to someone then either you must pay it off or the amount will be deducted from the value. Note – this is debts such as loans and does not mean trade creditors or normal PAYE / VAT or accruals as they do not impact the valuation.

What else affects the valuation of the business?

When this valuation is reached it is normally said to be subject to normal working capital. The standard approach usually requires looking at the normal trading pattern of the business, and what the stock plus debtors less creditors is in the usual course of trading. Then determining on sale, where the business sits in regard to usual trading and whether any adjustments need to be made to balance the differences.

For example, if at the date of completion, the debtor balance is double what it usually is, but the stock and creditors are the same as the average then it will be adjusted for in the sale price. This works both ways, so if it is something that means the working capital is lower than expected then the deal value would be adjusted down or adjusted up if the opposite is true.

The future potential of the business can also have an effect on the valuation. For example, if you are selling a quickly growing business that is seeing revenue increase significantly each year then you look at this, rather than just looking at the past profitability of the business as a methodology for valuation.

There are different ways this can be approached, often using forecasts as well as earnout mechanisms for how you reach the valuation. However, in essence the idea here is that if the business has a very bright future with a much greater profitability possible in the future the valuation will reflect this rather than just the past performance.

Why Value a Business?

Another question you might have is why is having a business valuation important?

Well, if you are selling your business then like any sale, a buyer will themselves have a price in mind and so you need to have one too.