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Five-minute money masterclass: How to value your business

Written by Adam Pescod on Wednesday, 05 February 2014. Posted in Investment, Finance

When a big exit or investment is on the horizon, it isn’t something an entrepreneur can afford to get wrong. Thankfully, help is at hand from those in the know

Five-minute money masterclass: How to value your business

We’ve all seen budding entrepreneurs get panned on Dragons’ Den for the valuation they have put on their business. Whilst you have to admire the confidence displayed in the majority of cases, one can’t help but think that those leaving the Den with empty pockets do so with a sense of ‘what if?’ What, indeed, if they had taken the time to come up with a more realistic figure with which to approach their potential investors? The first thing to say is that valuing one’s business is no straightforward endeavour. There’s a lot more to it than a calculator and stack of paperwork.

 Profit from your profits

Ultimately, a realistic business valuation will be founded on the current and future profitability of a firm. “The starting point must be ‘what is the underlying profit of the business?’ and the key word there is underlying,” says Mark Hughes, corporate finance partner at law firm Browne Jacobson. “What people generally mean by that is the profit that is going to be there from one year to the next.” Depending on the sector within which a company operates, a multiplier is usually applied to the profit to determine the total value, offering an indication of when a buyer or investor will start to see a return on their money. “In a sense, what you are saying is ‘if I bought this business today, how long will it take me to get that money back?” Hughes adds. “So if you buy a multiplier of five times the annual profit, it will take you five years to get your money back.”

 Have the buyer or investor in mind

Whilst you may have a value in mind for your business, there is a fair chance that whoever is considering purchasing or investing in it will have an alternative figure on the table. Whether that comes as a result of their own financial situation or a skewed perception of your business, it ultimately pays to put yourself in their shoes as well as your own. “It is not helpful for people to think about valuing their business in isolation of who the value is in the hands of,” says Jim Houghton, partner at M&A advisers Results International. “If you don’t have a buyer in mind when you are thinking about value, you can’t get valuation right.” Essentially then, true value is a price that both parties are happy with. “The simple answer is the right value is what you are prepared to sell it for and where that overlaps with what somebody else is prepared to buy it for,” concludes Stuart Morris, entrepreneur in residence at Henley Business School’s Centre for Entrepreneurship.

 Compare the market

When it comes to putting a value on your business, taking a look at what other firms in your sector have sold for can also provide some useful guidance. Indeed, this can be of particular use if one’s enterprise isn’t yet at the profit-making stage. “With a business without net profit, on top of looking at the multiple, you would also look at what other similar businesses in that industry are worth. What have other comparable businesses sold for at this particular stage?” says Raj Dhonota, investor and serial entrepreneur. “For example, if you build something like Twitter that is completely unique, you can look at Twitter’s growth to give you a rule of thumb before looking at the competition and everything else around it.”

Add up your assets

The money-making potential of one’s enterprise is naturally going to have a significant bearing on how far into their pocket a buyer or investor is prepared to dig. However, there are other factors that serve to give the enterprise its monetary worth and which should be taken into account from the outset. “In the context of a start-up, brand and market presence is likely to be of less relevance but you might have a particular asset that is of value,” says Hughes. “For example, if you have got the UK distribution rights to a new product, that may be really important from a valuation perspective. Somebody may want to buy you out purely to get the benefit of that contract or to buy out that arrangement that you have got.” Other such assets could include a firm’s management team and, if it is a web-based proposition, the size of its client base and overall digital reach.

 Have it all in front of you

An understanding of the components that make up business value is one thing, but the process itself can be all the more challenging without access to up-to-date facts and figures. With these in place, it should be a far smoother ride. “The minimum that somebody needs to do is have a really solid set of numbers regularly produced by the business; monthly management accounts that explain the margins on products and all those types of things,” says Sanjay Swarup, director at accountancy firm SKS Services. “If I wanted to sell SKS today, it would be very easy because we have monthly management accounts and everything is explained. If I didn’t have management accounts and I just produced something on the fly, the credibility on those numbers is not that high so people will discount on the value straight away by 20-30%.”  

About the Author

Adam Pescod

Adam Pescod

EB's former editor, Pescod was tasked with ensuring these hallowed pages are rich with excellent, engaging and error-free stories, all written with the entrepreneur in mind. Pescod previously plied his trade penning pieces about pubs and pints. He is also a sucker for alliteration. 

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