Introduction
Selling your business is one of the most significant decisions you can make, and understanding your business’s worth is crucial to achieving the best possible outcome. Whether you’re planning your next venture, considering retirement, or responding to market opportunities, knowing your business’s value helps set realistic expectations and prepares you to negotiate effectively.
Valuation is complex – but whether you’re just starting to explore selling or are actively preparing for a sale, the following article will simplify the process and break down the key factors that influence business valuation. These include revenue, profitability, industry trends, and market demand. You’ll also learn about common valuation methods, providing you with the tools and insights needed to make informed decisions.
Why Understanding Your Business’s Value is Crucial
Valuation can be a contentious topic in the world of mergers and acquisitions (M&A). Buyers may feel that sellers are overpricing their companies, while sellers might believe buyers are being overly pessimistic. The reality often lies somewhere in between.
A well-informed valuation acts as the foundation for a smooth and successful sale. It provides you with confidence in your decisions, aids in effectively communicating your business’s value to potential buyers and helps ensure you achieve the best possible outcome. Whether you are planning to sell now or preparing for a future sale, understanding your business’s value is a crucial first step.
Our guide How to Value a Business explores the methodology behind valuations in more detail, if you want to explore the topic further.
Key Factors That Influence Your Business’s Worth
When potential buyers evaluate a business, they consider several key factors to determine its value. Understanding these elements will not only help you prepare for a sale but also allow you to highlight your business’s strengths. So, what do buyers typically assess?
Financial Performance
Buyers scrutinise revenue, profitability, and cash flow. A company with steady or growing profits is often valued higher than one with erratic financials. For instance, a business generating £500,000 in annual profit with consistent growth trends will likely command a premium compared to a similar business with fluctuating earnings.
Market Position
A business’s role within its industry, such as market share, growth trajectory, and competitive landscape, significantly influences its valuation. For example, a company with significant and/or growing market share would be seen as more valuable than one that struggles against numerous competitors.
Assets and Liabilities
Both tangible and intangible assets contribute to a business’s worth. You should be careful to ensure the value of any tangible assets is accurately stated, and also bear in mind that property (even if the business operates out of it) is unlikely to be included in a sale and should be excluded when it comes to valuation. Intangible assets such as intellectual property, brand reputation, or proprietary technology can be game changers – but you will need to make sure that any IP is appropriately protected and be prepared to demonstrate any value you attribute to intangibles.
Growth Potential
The more scalable and future-ready your business is, the more attractive it becomes to buyers. If you can demonstrate clear opportunities for expansion, such as entering new markets or launching new product lines, it can significantly boost valuation. For example, a tech startup with a proven product and plans for international expansion will typically be valued higher than a company with limited growth prospects.
Customer Base
A diverse, loyal, and recurring customer base indicates stability and reduced risk for buyers. In contrast, a business with a concentrated customer base, where only one or two clients account for the majority of revenue may be seen as a risky acquisition.
Overview of Common Valuation Methods
There are various methods the corporate finance industry uses to assess the value of a business, although they will invariably involve applying a multiple to a figure that is deemed to represent the financial performance of the business. While the most common method is a multiple of Earnings Before Interest Tax Depreciation and Amortisation (EBITDA), other approaches include Accounting Rates of Return (ARR), Internal Rate of Return (IRR) or Discounted Cash Flows (DCF). Here are the most widely used approaches:
Asset-Based Valuation
This method determines a business’s net worth by subtracting liabilities from the value of its tangible and intangible assets. Commonly used for asset-heavy companies like manufacturers or real estate firms. For example, a company with £12 million in assets and £2 million in liabilities would be valued at £10 million.
Market Comparisons
This approach establishes a value based on similar companies who have recently sold. It’s most suited larger businesses where a good amount of data can be found on public listed companies and comparable transactions. For instance, the recent acquisition of Randlab by Animalcare Group for £62m could be used to infer the potential value of your equine veterinary business – as long as suitable comparisons can be drawn in terms of size, market position and opportunity.
Income-Based Valuation
This method evaluates a business based on its income potential, using metrics such as profit, cash flow, or earnings multiples. It’s the most common way of valuing a business as it offers the clearest measure of return on investment. For example, if a company’s profits are £500,000 annually and the industry average multiple is five times earnings, the valuation would be £2.5 million.
Each method offers a different perspective for assessing value. By choosing the approach that aligns with your business type and objectives, you can achieve a more accurate and well-rounded valuation.
Buyer Types
Whichever method you use to arrive at a valuation it is worth considering the different types of buyer, as motivation can have a significant impact on valuation. In broad terms, the two types of buyer are financial and strategic:
- Financial Buyers are primarily motivated by a return on investment, their primary focus will be on profitability and growth.
- Strategic Buyers will be looking for synergies, such as expanding market share or acquiring intellectual property and may be less driven by multiples of earnings – consequently strategic buyers often bring higher offers to the table.
Step-by-Step Example: Using Earnings Multiples to Estimate Value
A more detailed explanation can be found in our guide How to Value a Business. But here is a simple scenario to give you an idea.
Step 1: Determine Adjusted Earnings
To ensure you are getting a true picture of the underlying performance of the business you will need to adjust your profit figure for exceptional items and things that would either not be there under new ownership or would need to be introduced to replace outgoing shareholders.
- Starting with an EBITDA of £500,000 your Adjusted EBITDA is now £600,000
Step 2: Research Industry Multiples
You analyse 10 historic deals in your sector, and they range between 3x EBITDA and 8x EBITDA. Taking an average and allowing for margins of error, you decide a sensible range would be 4–6x EBITDA.
Step 3: Calculate the Value
Multiply your adjusted EBITDA by the selected multiple:
- £600,000 x 4 = £2,400,000
- £600,000 x 6 = £3,600,000
Final Valuation:
It can be estimated that your business might be valued at £2.4m to £3.6m. Of course, it’s never as simple as that – see the guide for more information.
By selecting the appropriate multiple and ensuring accurate earnings adjustments, this approach offers a reliable estimate of your business’s market value while accounting for industry trends and buyer expectations.
Adjusting for Intangibles: The “X Factor” in Valuation
When valuing a business, demonstrable measures like profitability, recurring income and tangible assets are complex enough to calculate. However, it is often the intangibles that drive real value… the opportunity the acquisition offers the acquirer in terms of new markets etc…, brand reputation, customer loyalty, and intellectual property are all factors. The biggest intangible though is buyer motive, why are they really interested in buying your business?
Showcasing Intangible Strengths to Buyers
Effectively highlighting these strengths for potential buyers is key, focus on measurable impacts, highlight customer retention metrics, emphasise exclusive intellectual property rights, and show them that you know what benefits the will gain by acquiring the business. By demonstrating the value of these intangibles, you can position your business as a more attractive investment.
Common Mistakes Sellers Make in Valuation
Valuing a business can be an emotional and complex process. Here are some common pitfalls to avoid:
- Using the wrong metrics to determine value
As a business owner, it’s natural to have a view on what your company is worth. But often these views owe more to what they feel they need to get out of the sale, or what they feel they have invested in the business (emotionally as well as financially). While these factors shouldn’t be ignored, because they will help you decide if you should proceed, they need to be understood in the context of a more logical assessment of value as described above.
- Ignoring market conditions or industry trends
Booming industries boost value, while declining markets can lower it. Overlooking these factors risks giving a false impression of value. Stay informed about current industry benchmarks and market conditions and adjust your valuation accordingly.
- Neglecting financial inconsistencies
Disorganised financial records, unexplained losses, or irregularities in reporting can harm buyer confidence and decrease the business’s perceived value. It’s essential to maintain accurate financials and conduct an audit before presenting your business to potential buyers.
- Overlooking buyer motives
Although hard to translate into tangible value, you need to remember that the motivation of a buyer will have a significant impact on the value they are prepared to place on the business – this is why any valuation you do should look at a range rather than a single figure.
- Relying solely on one valuation method
It’s worth remembering that different valuation methods have their own strengths and weaknesses and you may need to consider more than one method to get a complete picture of a likely valuation range for your business.
Practical Advice for Sellers
- Get Expert Guidance: Engage with a professional corporate finance advisor to provide an impartial valuation.
- Prepare Thoroughly: Tackle potential red flags, such as financial inconsistencies or outdated equipment, before approaching buyers.
- Be Transparent: Share your challenges openly to build trust with buyers and maintain your credibility.
By avoiding these common mistakes, you’ll not only preserve your credibility with potential buyers, but also pave the way for a smoother negotiation process and a more successful sale. For more insights, check out our complete guide on Avoiding Pitfalls When Selling a Business.
Why a Professional Valuation Can Be Worth the Investment
Partnering with an experienced M&A advisor can significantly enhance your chances of a successful sale. While DIY valuations might save costs, the expertise of a professional often delivers better results, particularly for complex businesses.
A professional valuation not only determines your business’s worth but also strategically positions it to attract the best offers. By leveraging industry insights, providing unbiased assessments, and offering strong justification for your asking price, you’re more likely to achieve a sale that reflects your business’s true value. Here’s why:
- Access to Industry Benchmarks
Professional valuators have access to extensive market data and industry-specific benchmarks, allowing them to provide a realistic valuation based on current trends. This ensures your perception of value is more likely to align with that of serious buyers in the market without undervaluing your hard work.
- Unbiased Assessments
As a business owner, it’s easy to let emotions or personal biases cloud your judgment. A professional offers an objective perspective, focusing solely on the business’s strengths and weaknesses from a buyer’s viewpoint. This impartiality enhances the credibility of your valuation.
- Strengthening Negotiation Positions
A well-prepared valuation report can be a powerful tool during negotiations. It provides buyers with a clear, evidence-based justification for any push-back on offers, which shows that you are well prepared and they need to take your business seriously.
The Importance of Professional Guidance for Complex Businesses
For larger or more complex businesses, seeking professional guidance is even more crucial. These businesses often feature:
- Multiple revenue streams.
- Significant intangible assets, such as intellectual property or brand equity.
- Complex financial structures or ownership arrangements.
An experienced M&A advisor can effectively navigate these complexities, ensuring nothing is overlooked and that the business maximises its appeal to the right buyers.
By investing in a professional valuation, you set the stage for a more successful sales process.
Steps to Prepare Your Business for a Higher Valuation
One of the most common questions we receive is, “How can I increase my business valuation?” Maximising your business’s valuation requires careful preparation and proactive efforts to highlight its strengths. By focusing on key areas that enhance value, you can attract serious buyers and command a higher price. Below are actionable steps to prepare your business for a higher valuation:
- Growth potential of the business
Create and formalise credible business plans that illustrate the future growth potential alongside supporting notes that demonstrate the achievability of these plans.
- Recurring revenue
It’s good practice to review your client base, wherever contracts are in place, the longer the better. It may also be worth considering if you could transition or introduce a subscription-type model, services and maintenance contracts that will generate recurring income. In either case, you want to show buyers what portion of your company’s revenue is predictable and stable and how it can be counted on in the future with a high degree of certainty.
- Scarcity
Scarcity essentially refers to the level of difficulty a buyer would have in replicating aspects of your business without making an acquisition. It could refer to skill sets, experience, product development, manufacturing techniques, and a whole host of other things, including how often businesses like yours come up for sale. There are three things you should do to make the most of scarcity in a business sale situation. Identify, document and protect, so that you can communicate scarcity to the buyer and they can be confident the scarcity won’t disappear once the deal is done.
- The buyer’s motive
This is mostly something that is influenced during the negotiation phase of a deal, once you know more about what the motives of the buyer actually are. However, it is worth spending some time reviewing how the existing infrastructure of your business can help bring various possible strategic motives to life for certain types of acquirers.
- Impact of having options.
Get help with scoping out various potential buyers so that you can market your business more widely and create a ‘bid’ atmosphere that sparks healthy competition – and gets you results.
These efforts, combined with professional guidance, position you to achieve the highest possible valuation when it’s time to sell. For further insight, read our article 5 Things That Will Drive Your Business Valuation Up
Conclusion: Understanding and Maximising Your Business’s Value
Determining your business’s value is more than just calculating a number; it’s about laying the groundwork for a successful sale. Understanding the worth of your business helps establish realistic expectations, attract the right buyers, and negotiate effectively.
Adopting a strategic approach to valuation is essential. Each step improves your chances of achieving a favourable outcome. Professional support provides the expertise and objectivity needed to navigate the complexities with confidence.
A well-executed valuation process is the key to unlocking your business’s full potential. With careful preparation, strategy, and determination, you can achieve a sale that truly reflects the value of your hard work.
If you would like guidance on valuing your business or would like to discuss your exit options, please contact us, call 08450 678 678 or email [email protected]
