Company owners looking to sell up will need to know how much their business is worth. A valuation is also necessary for the purposes of raising capital, being involved in a merger or acquisition or for succession planning. Although sellers will usually require professional help to put a price on their business, nevertheless, they should know what the main methods are and which are appropriate for them.
Essentially, they are divided into three categories: earnings based, market based and asset based. Here we will be focusing on market-based and asset-based valuations as the first of these is covered in another article called I'm Thinking Of Selling Up: How Do I Value My Business?.
Market-based valuations
These include doing a comparable company analysis or basing the valuation on the market capitalisation of a similar sized listed company. They are appropriate for buyers who are choosing which company in a sector to buy. Common techniques include the following.
Market capitalisation
This is only appropriate for companies that have issued shares. The share price is multiplied by the number of shares at issue to arrive at the company’s value. Often buyers pay a premium on the actual share price to get the deal over the line. A private company owner looking to sell might find a public company with similar financials and base the valuation on that company’s market cap.
Enterprise multiple
The valuer will work out the enterprise multiplier based on the sector the company is in, how it relates to competition, the cost of its capital and the robustness of its financials. A high street business is likely to have a low multiplier whereas, say, a tech company with good growth prospects will have a higher one.
Comparable company analysis (CCA)
In this case financial metrics such as the price/earnings ratio or the enterprise multiple or Ebitda ratio are used to compare companies in the same sector.
Alternatively, a valuer can use an enterprise value/Ebit ratio. Enterprise value is the value of the business expressed as assets minus liabilities. This is divided by annual earnings before interest on loans and tax. A lower ratio relative to competitors suggests better value for investors.
Private company owners can ‘read across’ from comparable public companies’ financial data to gain an estimation of their own business’s worth. However, allowance must be made for the fact that a private company will usually be worth less than a public one of similar fundamentals because it has less access to capital and is seen as more vulnerable to market vagaries.
Where possible, looking at previous buyouts in a sector can be helpful. The valuation multiples, subject to variation for differences between the comparison companies, can provide a realistic figure for what a sale might yield.
Asset-based valuation
The company’s value is determined with reference to its tangible and intangible assets, for example, book value (assets minus liabilities), liquidation value and replacement cost analysis. This is best for buyers, who are primarily interested in the company’s present value.
This method tends to give lower valuations than other methods, as the valuer will typically only look at the value of an unexpired lease (if transferable),unsold stock, equipment and tools. It will be hard for the owner of a high street business, eg, a shop or nail bar, to talk up the price significantly based on customer numbers or possibilities of future growth, especially in the case of owner-managed businesses, where customer loyalty may well remain with that person.
Liquidation valuation
This estimates what the company would be worth if it failed by looking at what would be left after liabilities were settled and assets sold. It is used when a company goes bankrupt, is being liquidated or is in distress.
Book valuation
The liabilities of a company are subtracted from its assets. What is left is what the company is worth. While its simplicity is attractive, it risks overlooking the value of intangibles such as loyal customers and future prospects.
Entry valuation or replacement cost valuation
This straightforward approach suits newer businesses. The value is arrived at by working out how much it would cost to start a similar business. Typically it will include things like the cost of acquiring physical assets, hiring and training staff, marketing and customer acquisition, and developing products and services. A buyer won’t want to pay for inefficiencies in the start-up processso any money wasted in the early days will have to be discounted from the valuation.
The disadvantage of this method is that it takes no account of future earnings or growth potential, making it unappealing to companies with a more established financial history relative to other valuation techniques.
What do to next
Valuing a business requires expert advice to ensure the accuracy of estimated data and financial projections. This article only touches on the issues involved and anyone seriously considering valuing or selling their business will need bespoke professional help.
The friendly team at Finsbury Robinson’s valuation service will be able to deal with all your questions and give you advice tailored to your individual business. If you want help with valuing or selling your business, please call us on 020 8858 4303 or email us at info@finsburyrobinson.co.uk.
