Establishing the value of your business can be difficult. While well-known valuation methods can give you a rough idea, ultimately your business is only worth what someone is prepared to pay for it. The right approach to negotiating a sale can have a big effect
There are several standard techniques that can be used to provide a benchmark valuation for your business:
- price/earnings - based on multiplying your business' profits by a particular ratio (the price/earnings ratio);
- asset valuation - based on the assets your business holds;
- entry valuation - based on the cost of starting a similar business from scratch;
- discounted cash flow - based on likely future cash flow;
- industry rule of thumb - if your particular sector has its own established valuation formula.
Using two or more different valuation methods can help you come up with a range of valuations for your business.
It’s important to realise that these valuations, and the amount a purchaser is in fact likely to be prepared to pay, may be substantially lower than the value you place on your business.
Factors influencing value
The value of your particular business is likely to be affected by several factors:
- Growth prospects - the better your growth prospects, the more your business is worth.
- Risk - the smaller the business, the higher the risks tend to be and the less a purchaser will pay. Small, owner-managed businesses are particularly risky for a new owner to take over.
- Special features - skilled employees, intellectual property or other special strengths of your business will increase its value.
- Opportunities - your business will be worth more to a purchaser who can increase profits (for example by cutting costs, or selling your product to their existing customers).
- Cost of financing - a purchaser is likely to pay less if their cost of financing the purchase is high.
- Supply and demand - your business may be worth more if it is unique, or if there are several buyers looking to purchase that kind of business.
Achieving a high sales value
Do what you can to make your business as valuable as possible.
The more time you have, the easier it will be to show your business in the best possible light. Concentrate on boosting short-term results to get the best possible profit record before you offer your business.
Think about timing
If possible, put your business up for sale when business conditions are good, and when business valuations are high. You’ll also be in a stronger negotiating position if you aren’t under pressure to sell immediately.
Reduce business risk
If you are over-dependent on a few customers, try to diversify your customer base. If one or two employees are crucial to the success of your business, consider ways to tie them in. If trade marks or other intellectual property are important to your business, make sure they are properly protected.
Sort out systems
Strong management information systems give the purchaser confidence that there won’t be any unpleasant surprises.
Market your business to attract potential purchasers. The price will be higher if there are competing purchasers.
Structure the deal
A structured deal may increase the price the purchaser is willing to pay. For example, you might commit to continuing to manage the business for a year or two, or link the price to future earnings - reducing the purchaser’s risk. Being willing to defer part of the purchase payment may also encourage purchasers.
Plan for tax
Making sure the deal is tax-effective for you can have a dramatic impact on the net value you receive.
Your legal adviser can offer specialist knowledge and negotiating skills to help you.