One of the first steps to selling your company is working out how much it’s worth. As corporate finance experts, a question we hear all the time is, “how do you value a business?”
Our answer always starts with “a business is worth what someone is prepared to pay for it”. Rather than putting a price tag on your business when you take it to market, it will be more beneficial if you provide all the necessary information a potential acquirer will need to make an offer on your business – one that reflects its full worth.
Acquirers will use various methods to help price a business depending on what sector the business operates in and what type of business it is, including: asset valuation, discounted cash flow, rule of thumb, entry costs, price/earnings for listed companies and multiples. With all these aspects taken into consideration, your business could actually be worth more than you realise…
However, as a company director or shareholder, you’re probably looking for guide as to the approximate price category your business falls into. Multiple valuation is one technique you can use to achieve this.
How do you value a business using multiple valuation?
In very simple terms, multiple valuation it’s the profit of the business multiplied by the Industry Average Multiple (I.A.M) (for the sector the business operates in) which then provides you with a basic valuation
Profit x I.A.M = value
Getting into the finer detail
Often the profit figure in any given year may be distorted by exceptional, one-off or non-recurring items which could adversely affect a multiple valuation. If this is the case, then the profit should be adjusted accordingly to truly reflect the worth of the business. These adjustments are called ‘add backs’ (vendor one offs/non-recurring items) and ‘add forwards’ (costs that may be incurred by the new owners moving forward).
Examples of add backs could be items such as director benefits, pension contributions, office refurbishment, redundancy payments, the company’s 25-year celebration party costs, your salary if you are leaving the business, and so on. All these are costs that would not be incurred by the new owners.
An example of an ‘add forward’ might be the cost of a new Sales Manager/Director – if you are the MD of the business and you also currently look after the sales then you will need potentially to be replaced.
A more detailed valuation of your business would take the EBITDA (Earnings Before Interest Tax Depreciation and Amortisation) of the business and then apply ‘add backs’ and ‘add forwards’ to provide an adjusted EBITDA figure which better reflects the true profit of the business.
You need to be fair and realistic with both add backs and add forwards; don’t over egg it otherwise you could come unstuck or you might put your buyer off.
Once these add backs and add forwards have been applied, the result will be an adjusted EBITDA figure, to which you can then apply the industry average multiple to get your guide value.
However, please note that this is only a desktop exercise and does not take in to account the value drivers that are not shown in the accounts, which could add significant value and help increase the multiple. We will share some of those with you in our next blog.
To conclude
Depending on the information you provide and the type of multiple methodology your potential acquirer applies, this could have a significant impact on the value calculated. That’s why you never put a price on your business at the start but present all the necessary information to a potential acquirer and then allow them to value your business. You may be pleasantly surprised.
This article is provided for general information purposes only and is not intended as specific advice for how to value a business.
If you would like advice for your unique business needs and a guide valuation, then please contact us in confidence on 0845 067 8678 or [email protected]
