How should I value my business?
There may come a time when you will need to be able to provide a valuation for your business. This could be because you are looking for investment. Take the BBC show Dragon's Den, for example; if your valuation isn't deemed accurate then you may not walk away with the investment you are looking for.
What are the different methods?
There are several different methods that you can use in order to valuate your business. These include the following:
Multiply your profits
This common method of valuation is carried out by multiplying the current profits for your business. This method is better for businesses that are currently trading and producing a profit.
In order to use this method you will need to know what your current annual profits are, you will also need to make a note of any large, one-off purchases that wouldn't normally have occurred (this could include purchases of new assets). These will have to be removed so that your profit will be a true reflection.
Take this figure and multiply it by between 1 and 5 times, depending on the expected growth of the business and taking into account your own industry. If your business is a small start-up then use the small end of the numbers so you are not overestimating the likely outcome. The more modern businesses are often thought of as more valuable and could use the upper end of the scale, or even beyond it. It is suggested that you start at 2, then using the list below, adjust the figure accordingly.
You should also consider other important factors which are unique to your business, such as new product launches, hiring new staff or moving to a bigger premises. These could all affect your profit.
- Positive factors that can increase the multiple, such as:
- Sales and profits have risen consistently each year for at least 3 years
- A significant amount of sales come from repeat customers
- Proprietary products, patents and/or trademarks
- Exclusive rights to a territory
- Less warranty exposure than is typical in your industry
- Management and /or employees will stay on after the sale of the business
- The business is a franchise of a well established - and well known - company
- Your industry is growing and the future appears bright
- Important ratios such as profit margin are above average for you industry
- Negative factors that can decrease the multiple, such as:
- Sales and profits have been trending down recently
- Sale and profits have been inconsistent or unpredictable in the recent past
- Sales from your most important product have been down or stagnant
- One customer accounts for a large portion of your sales - for example, more than 20%
- There are many businesses similar to yours that are also for sale, or your products are widely available at many places
- The business relies heavily on location for its success but the lease is not transferable or is about to expire
- Pending legal or government issues such as law suits or environmental concerns
- Important ratios such as profit margin are below average for you industry
- A large amount of obsolete inventory
- The business is part of a weak franchise or one with a bad reputation
- Too many old accounts receivable that will never be collected
Once you have worked out and used your multiple you'll end up with a value, which hopefully, will represent the total profit for your company in 3-5 years' time, assuming all of your projections went through and you've taken into account the relevant factors. This figure can, and probably will, change depending on the actual performance of your business. With this in mind, it's worth updating this figure as and when you need it.
Value your assets
This is a good method to use if your business is in the manufacturing industry, or another similar industry where your business has a great reliance on a large number of assets such as equipment, tools, warehousing, transportation, or if you own a physical shop, any stock held is then classed as an asset on your balance sheet. Also, for online businesses, your domain name can be classed as an asset, if your name is sought after then you can have a high valuation on it. Similar cases can apply to trademarks and patents if they are valuable.
To use this method of valuation, you simply look at the total value of the assets you have, minus liabilities. This will not take into account any inflation or depreciation, your assets should be valued at the current market rate.
Barrier to entry
This will vary from business to business. For example, if your business has an established customer base, good physical location, has already marketed in the local area and has bought a suitable premises then it would be valued more highly than a business that was only just starting out and only had one or two things from that list.
This is a less tangible way of valuing your business because you are working with speculation rather than fact. But knowing the size of the market and your current market share you can have more influence over the way your business is perceived.
What's the best option for my business?
If you have been asked for a valuation for a specific purpose then it's probably best to speak to an accountant who can advise you on what would be the best for your business. However, if you're just curious, then hopefully we've provided you with enough information to get you started.
Looking for an accountant? Check out our sister site Find An Accountant.