How do I value a business?

How do I value a business ?

After finding the right target business, a business valuation is the first stage in starting the process of negotiation on the final purchase price of a business.

There are many valuation methodologies but for the SME market and more specifically, those businesses with ebitda (earnings before interest, tax, depreciation and amortisation) of less than £1m, then the “multiple of ebitda” method is probably the most relevant.

The range of multiples used is typically but not exclusively between 3-6 times. This means that a business can be valued based on its annual profit (after being adjusted for any current owners discretionary spending and personal items to which a new owner would not necessarily need to commit*) with a multiple being applied to the profit to give a valuation figure. The actual multiple applied is influenced by a number of factors including the following:

• Formal contracts with customers / suppliers and the length of these
• Retention of equity by an existing owner upon the sale transaction taking place
• Patents / Intellectual property (TP)
• Defensible products/technology/market position ie many barriers to entry for a newcomer to the market
• Formal employment contracts for staff
• Strong internal systems and processes being in place
• Robust financial management procedures and cashflow forecasting in place
• Key second tier management staff being retained
• The sector. Certain sectors carry a higher multiple. This is particularly true of tech businesses and specifically those in the fintech sector

Once you have a valuation, you will probably wish to explore that with the vendors advisers to see whether it is in the right “ballpark” for their client. If so, you can work on the structure of the offer in some detail. This is covered in a separate section in the Valius knowledge library.

*These items include pension payments; additional salaries for family members not likely to be retained in the business post-sale; personal healthcare and any other personal/one-off costs incurred.

There is no right or wrong answer on how to value a business.

Many business valuations use a matrix model which “normalises” one-off high/low profit years and takes account of the general run of trade over a longer period of time rather than valuing the business based on the prior year’s results, which, if it has been a particularly strong year, can give an inflated valuation, which definitely won’t suit a buyer.

There is a very good chance that the sellers won’t agree with your method of valuation and will disagree with your ultimate figure for value. This is normal behaviour. The seller’s advisers will probably have their own method and the seller might even have a specific figure in mind which will likely have been influenced by discussions with their advisers. It’s really a negotiation process from here and it’s about finding a position which is acceptable to both parties. Effectively the place you need to arrive at is the position of a willing seller and a willing buyer. This needs to exist for a deal to take place.