Struggling to work out what the actual value of your business is?
What method to use, what figures to include, and what about including the potential?
If you’re considering selling up, have considered it, planning to or just straight up interested in what your business is worth, I’ve detailed below the 5 most common methods of valuing a business and what they mean. (And keep an eye out as in the coming weeks I’ll be discussing what you could do to increase them. )
Firstly, why do this?
- Because it gives you context and helps to manage expectations. Spending 60 hours a week building a business from scratch better be worth something… but the figures will tell
- Because it will help you focus.
- Less than you expected? Having an external calculation on your business, without taking your internal optimism and explanations into account can help a situation hit home bringing into focus what you need to do (or stop) to improve
- More than you expected? Hooray, but what’s next, time to revisit you plans
- Because the more information you have, the better decisions you can make. Got an offer on your business you don’t like? Want to start negotiations off on the right foot? Want to know performance and set new targets and KPIs?
For all these reasons and more, a detailed business valuation report will help.
So, on to the methods…
The most common way to value a business is a multiplication of EBITDA (Earnings Before Interest Tax Depreciation and Amortisation).
What multiplication rate?
Some business owners like to use a finger in the air approach to come to a figure they’d be happy with. Unfortunately this often doesn’t work out in reality… unless you’ve managed to create a product that’s key to another businesses growth, think of Salesforce buying Slack (which was running at a loss) for $27.7B!
Actual multiplication rates depend on the industry and can range from 1x to 20x+ (for the big tech companies) and this is for listed companies. For SMEs the figure is lower and can vary depending on turnover, year on year growth and profit margins. Below is an extract of business sector rates along with an example of what it would be for SMEs (at 1 fifth of the size of listed companies):
|Business Sector||EBITDA Multiple |
|EBITDA Multiple |
(SME at 1/5th size)
Next is assets value of the business. Simply put, this is the net book value of assets adjusted for real value. i.e. stock depreciates in value, debts unlikely to be paid should be excluded, property updated to current value, fixtures and fittings may be in disrepair and need to be devalued etc.
Next valuation, used more if you are a new company that can be replicated, is the entry cost. This means the total resource it would take to create your company from scratch.
In short, this is the cost of employing people, training, certifications, developing products and services, building assets and a client base LESS
Any savings that could be made when setting up, e.g. locating the business somewhere else or by using cheaper materials
Rule of Thumb
The penultimate valuation we consider is rule of thumb, i.e. the valuation based on industry standard. This is a multiplication of profit which depends on whether the owner is hands-free (6x) or still running the day to day (3x). Plus stock, equipment and other fixed assets.
So if you want to increase the value of your business here, you need to start taking more time off and have the processes, systems and staff in place.
Discounted Cash Flow
Last but not least is the discounted cash flow method, an estimate of future cash flows for the business revalued to todays value (as a £ or $ now, is worth more than a future £ or $).
Generally, this is the dividends for the next 15 years at at discounted rate of 25%.
And for all the excel buffs out there, here is the formula:
What’s not included?
Now you know what IS included in each valuation method, it is time to know what IS NOT which can then be used to support an increased value of your business. These could include:
- Future contracts
- Key software
- Strategic location for potential buyers
- The value of your data to the buyer
- New technology
- Year on year growth
- and more
Whatever your plan is with your business, noting down and regularly reporting one or more of these methods of valuing your business to track it will let you know whether you are on the right track or not.
If you are looking for a valuation now, showing all five of the methods above, click the link below and get your free report.
I hope you’ve found this useful. Let me know if you have any other valuation methods that we should be including here or any questions you have.