Thinking of Valuing Your Business?
No matter where you are in your business journey, it is important to know the value of your business. Whether you are selling, merging or planning for your business's future, getting an accurate valuation is beneficial. It will attract the best buyer so that you receive an accurate financial reward for your investment of time and resources over the years.
This guide will run through the valuation process step by step. We discuss the best ways to go about getting an accurate valuation for small and large businesses and what factors will impact the process. You may need a quick valuation of your business, or you may want to take your time and get a more detailed valuation. Regardless of your preference, this guide offers valuation methods that will suit the needs of your business. You may need professional tools and resources in the valuation process, so read on to discover what you can expect.
What is a Business Valuation and Why Should You Consider It?
In essence, the purpose of a business valuation is to paint an accurate picture of your business's worth. Valuations consider some combination of the market value of assets, current and/or projected revenues and/or cash flow and other barometers of your business's health. Getting an accurate valuation will give you granular insights into its functionality and financial value.
Possible reasons for valuing a business:
- You want to know your business's value before selling it
- You want to gain a better understanding of your business so you can have practical expectations for the selling or buying process
- You want to find where the strengths and weaknesses lie
- You want to identify areas that need improvement
- You want to determine if its success is sustainable
Benefits of valuing a business
- Setting a credible asking price before selling the business
- Providing information that reassures buyers and reveals ways they can build further value
- To inform an exit strategy for growing, improving and eventually selling the business
- Securing capital investment from investors
- Setting the price of shares for purchase by employees
Criteria that Affect a Business Valuation
When it comes to selling a business, you will need to have a clear understanding of what it is worth before the negotiation process. It is important to know the current state of your business and its fair market value by assessing the following criteria:
- The circumstance of the valuation: this may be a voluntary or forced sale. This can impact the valuation and power dynamic during negotiations
- The value of your tangible assets: this can include cash, premises, land, machinery, furniture, stock, equipment and employees
- The value of your intangible assets: valuations can account for historic and projected profits, revenues and cashflow. Projections are estimated based on your intangible assets such as the business's age, goodwill, intellectual property, and the business's core values and culture
- The durability of these assets and wider economic conditions or external influences. For example, a gloomy economic outlook would not undermine the appeal of a recession-resilient business like a pawnbroker or convenience store. And a business whose revenues have been growing steadily over many years will offer the stability that is much prized by buyers.
Whether you are an established business or a start-up, considering these areas will give you a detailed outline of your business's worth to potential buyers.
The quantifiable parts of your business – like your turnover – will be simple to calculate. It may become more complicated when you consider intricate factors; you will need to have a clear understanding of your equity and share value if you want to bring in a partner. Intangible assets like goodwill or economies of scale play a significant role in the value of your business for future owners. Considering all these factors will illustrate where your business is and how it can improve.
Business Valuation Techniques
Naturally, how you value a small business (like a restaurant) would differ from how you value large enterprises like Amazon or Apple. Most business valuations consider the value of physical assets and income and often draw on multiple valuation techniques. We briefly cover these in our selling guide, but we will discuss them in more depth here.
The Asset Approach
This approach is effective for businesses that are asset-rich, like a property investment firm or manufacturers. Used alone, it is also useful for businesses in liquidation. The asset valuation method establishes the ‘net book value' (NBV) – or net asset value – by subtracting the total value of liabilities from the total value of business assets recorded on the balance sheet.
The resulting figure is then adjusted for factors such as changes in asset values, bad debt and ageing stock that must be sold at a discount. Keep in mind though; this approach does not consider future earnings or goodwill.
Seller's Discretionary Earnings
If you have a small or middle-market business, this method would be suitable. The SDE method considers your total cash flow including discretionary items like salaries, benefits, and depreciation. Remember to include your expenses in this method, like your rent and labor.
This method gives you a strong reflection of your business's profit potential by calculating what the business's earning would be with the buyer.
Price-to-Earnings Ratio (P/E ratio)and EBITDA
The price-to-earnings (or P/E) ratio method establishes the value of a company's earnings per share. Used to determine whether a limited company's stock price is overvalued or undervalued, it usually only applies to companies listed on the stock market.
Determining the most accurate number for your P/E ratio depends on your type of business. It is a good idea to compare your business's P/E ratio with others to find their relative value.
The acronym EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation. A company valuation based on EBITDA will look at the net earnings before any other facts are considered. Remember that this method ignores many factors that could impact the profitability of your business.
Entry Cost Evaluation
Entry cost valuation predicts what it might cost, approximately, to establish the business from scratch, including the cost of fitting out premises, employing and training staff, developing products and services, and establishing a customer base and reputation.
The hypothetical business must be built as cost-effectively as possible, for instance by locating premises in a less expensive area if this wouldn't credibly weaken profitability.
Discounted Cash Flow
The discounted cash flow method calculates the present value of projected cash flows. A discount interest rate – typically around 15%-25% – is applied to account for the ‘time value of money', whereby cash becomes more valuable over time due to its income-generating potential.
Based on long-term assumptions, this income-based approach is typically used by the largest companies with long, consistent trading histories such as banks, utilities and energy companies.
This relatively basic method calculates a figure based on valuations of similar businesses – in terms such as size, sector and location – that are available in the public domain.
How Can I Secure a Realistic Valuation?
The more you organise your business operations, the easier your eventual exit will be. When the time comes to sell, ensure you have a strategic framework in place that will impress potential investors and buyers. It will not only highlight your business's potential, but it will reduce any weaknesses your business may have.
Negotiation skills - confidence is key
If you have a clear picture of what your business is worth, you will be in a better position to negotiate the sale of it when the time comes. Understand where the weaknesses lie, what you can improve and what your future expectations for the business are. You need to be able to explain how you got to your asking price and why the assumptions underpinning your valuation are realistic. A comprehensive understanding of your business will boost your confidence in your negotiation skills.
Seek professional advice
When looking for someone to assist you in getting the right valuation, make sure their skills match your business. The person you enlist needs to be able to offer an impartial and well-informed valuation. Businesses will be valued in different types of ways, so ensure you find someone that has industry knowledge.
The size, type and sector of the business will impact the way that it is valued. Remember to consider the type of product or service that you offer and how this will impact the valuation. If you can find a professional who has successfully valued a business in a similar size and sector, it is likely that you will get an accurate fair market value.
While there are similarities that run through all valuation processes, each sector will have different circumstances. To illustrate the valuation process in practice, we offer some examples of different sectors below.
How to value a petrol station
Petrol station values are typically appraised using one of three valuation methods.
The income-based approach, which best suits gas stations with a long trading history of reliable earnings growth, is calculated by dividing a one-year cash flow projection by the market capitalization (or market cap) rate.
The market-based technique, meanwhile, arrives at a valuation based on the going rate for similar private businesses and comparable share values.
Finally, discounted cash flow, based on the current value of free cash flow available over the life of the business, can be credibly used by both long established, low growth businesses and high growth, market entrants.
How to value a retail business
You may have a small, one-person operation or a large retail space with several employees. Regardless of your context, you will need to have clear, detailed records of your business in the years leading up to your valuation. Ensure you have records of your percentage of sales, the value of real estate or lease duration, fixtures and stocks.
You should also compare your business to similar ones to see how it fairs with them. Comparing your business to others will give you a holistic understanding of the fair market value.
How to value professional service firms
Professional service firms – broadly defined as knowledge-based businesses such as legal, consultancy, and accountancy firms – are light on tangible assets and vulnerable to changing circumstances that weaken their intangible assets.
As such valuations are often based on projected earnings generated from historic trading performance, stellar reputation, intellectual property, products and services.
Much value also lies in the personal relationships between owner and clients.
Valuing Your Business with the ValueRight Online Tool
ValueRight is a free BusinessesForSale.com self-service valuation tool. To get all the benefits of the tool, ensure you provide as much information as possible when you begin the valuation. The process is relatively simple, and you can get a personalised valuation.
An advantage of using this tool is that your business will be compared to 20 years of BusinessesforSale.com data that will correctly benchmark and value your business. Inputting all your information into ValueRight will only take you around 45 minutes and all your information will be stored securely.
Before you start your valuation, remember to have access to at least a year's profit and loss statements. If you can, three years of statements will offer a more concise picture of your business and therefore, a better valuation.
The ValueRight service is free, and you can access it here. Once you have put in all the necessary information, you will be given a downloadable PDF report that you can keep, show to potential buyers or professionals who can evaluate the results. This document will be your business valuation report.
For more information, you can contact the support team.
Do You Still Need an Accountant?
When you are looking for an expert to help you evaluate your enterprise value, make sure you assess their experience and credentials. A suitable professional is likely to get you the right valuation, which will lead to greater exposure to the biggest market.
There are different services you can choose from, including an accountant, a business broker, lawyer or chartered surveyor. As we said before, their experience in valuing businesses like yours will be important.
If you enlist the help of a professional, you will need to pay a fee. If this is not the route you want to go, ValueRight can give you an accurate valuation for free. This route is encouraged for those that are worried about the business valuation cost. You can then list your business at a fair price that will attract potential buyers.
You can also take advantage of both options.
Our Rule of Thumb
With over 20 years of knowledge, BusinessesForSale.com understands the importance of valuing a business correctly. Thousands of businesses have been sold through our website, giving us insights into what buyers look for in a business and the most effective ways to advertise a business for sale.
Step 1: Plan ahead
The first important step to a satisfactory business valuation begins long before you enlist the business for sale. If you have an idea of when you want to exit the business, start to improve areas of your business that need attention so you can maximize its appeal. This will likely get you a better valuation before you sell.
Step 2: Prepare the business
There are a few ways you can prepare your business for a better valuation, and these will vary depending on the type of business you have. You may need to boost sales, build better goodwill, reduce operating costs or protect the business from long-term threats.
You could also improve the business by updating your training procedures or upgrading your software. Even the most basic improvements will improve your valuation. Ensure you get your paperwork in order and payments up to date. Identify if there are any areas that need to be updated, like record keeping.
Step 3: Get an accurate valuation
Finding a buyer hinges on getting a realistic, independent business valuation, along with careful preparation, effective advertising and perceptive negotiation.
Achieving this will be challenging without professional help, so it's worth checking out our services directory to find business brokers, accountants, lawyers and other business advisers.
The Last Step: Good Listing Increases Business Value
Of course, having a marketing strategy in place to get your business the best possible exposure is essential. Start by creating and distributing a well curated advertisement and list it on a platform that will guarantee exposure.
Your advert should embody features of your business that potential investors and buyers will find appealing. You should consider the following: a high footfall trading location; low rent or an easily transferable lease; a long track record of healthy, growing profits; unique and patented products; and availability of seller financing or owner willingness to stay on post-sale
BusinessesForSale.com is the biggest market for business sales, connecting more than a million business buyers and sellers each month. List your business with us to make sure you are visible to buyers in South Africa and beyond.
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