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How to value a business - Company valuation methods to determine how much your business is worth

By Edited Sep 17, 2015 0 0

How to value a business - Generally accepted company valuation methods

How to value a business? A question that is commonly asked when business owners reach retirement, are ready to move on, want a change or simply want out. At the end of the day a business is only worth as much as a buyer is prepared to pay for it so, valuing a business may seem like a costly waste of time however it is necessary to serve as a starting point to start the negotiations.

There are several company valuation methods small business owners can use to value their business so it should not be too difficult to calculate a value. So, what the tried and tested company valuation methods?

How to value a business - The net maintainable earnings method

Businesses with a record of sustainable earnings over many years are often valued using the net maintainable earnings method, which simply involves applying a multiple to the earnings.

When valuing a business in this manner it is important not to take the financial results for the best year, or even for the most current year but to take the financial results for five years, adjust the profits for any one-off and non-recurring expenses and then average the figures to arrive at a net maintainable earnings figure. Once you have the net maintainable earning you simply apply a multiple and the result is the valuation.  

The most contentious part of valuing a business using the net maintainable earnings method is deciding what multiple to use. The multiple is a subjective figure and there are many different things to consider when deciding which is most appropriate. Things to take in to consideration include
multiples used by businesses in the same industry, the share structure of the business, whether there are any minority shareholdings and whether there are any restrictions on the shares amongst other things.

How to value a business - The net maintainable earnings method

Businesses with a record of sustainable earnings over many years are often valued using the net maintainable earnings method, which simply involves applying a multiple to the earnings.

When valuing a business in this manner it is important not to take the financial results for the best year, or even for the most current year but to take the financial results for five years, adjust the profits for any one-off and non-recurring expenses and then average the figures to arrive at a net maintainable earnings figure. Once you have the net maintainable earning you simply apply a multiple and the result is the valuation.  

The most contentious part of valuing a business using the net maintainable earnings method is deciding what multiple to use. The multiple is a subjective figure and there are many different things to consider when deciding which is most appropriate. Things to take in to consideration include
multiples used by businesses in the same industry, the share structure of the business, whether there are any minority shareholdings and whether there are any restrictions on the shares amongst other things.

How to value a business - The asset valuation method

This one of the company valuation methods is ideal if a business is asset rich and has property, land, large pieces of plant and machinery etc. When valuing a business using the asset valuation method the starting point is the net book value of the assets in the accounts. The net book value of the assets are then adjusted for changes in market value, the general state of repair and what the asset would achieve on the open market.

When valuing a business using the asset valuation method it is advisable to seek the advice and assistance from other professionals as far as possible. For example, an estate agent can be used to value land and buildings, a professional stock valuer can be used to value stock and so on.

A business owner is going to want the values of the assets as high as possible, whereas a buyer is going to want the values to be low as possible. Because of this conflict in interests the asset valuations are less likely to be challenged if a professional valuer was used to value the assets.

How to value a business - The industry standard method

Some industries have standard ways in which to value a business and if your business is in one of these industries the industry standard valuation approach is the most suitable of the company valuation methods. For example, the value of an accountancy practice is deemed to be one year’s fees.

Since the methodology of industry standard method valuations are already laid down they require little thought. The valuations are also less likely to be challenged too much either, which always helps in the negotiation process.

How to value a business - The entry cost method

This is one of the company valuation methods where the business is valued based on the estimated costs incurred in creating the business from scratch. The costs would include things like buying equipment, employing staff, marketing the business and attracting customers, developing products and so on.

If all these entry costs can be accurately estimated this is a good method which to value the business, but it is rare in practice.

How to value a business - Combining two or more business valuation methods

There are times when the best way of valuing the company is to use a combination of two or more methods. For example, suppose there is an accountancy practice that has large freehold offices and a large piece of land out the back for which planning permission has been granted.

A business with substantial assets is often valued on an asset valuation basis but an accountancy practice is often valued on a year’s fees, i.e. the industry standard basis. So bearing this in mind, what is the best way to value this particular business?

The answer is to use a combination of the asset valuation method and the industry valuation method. In this scenario it is best to enlist the help of a professional valuer to provide a valuation for the freehold land and buildings and then add this to the last year’s fees figure in order to come up with a valuation.

There are many other situations where the fairest way to value the business is to use two or more of the company valuation methods described above.

How to value a business - What is the solution?

Valuing a business and company valuation methods is often described as an art rather than a science. There are some accepted business valuation methodologies, as explored above, but there are no hard and fast rules when valuing a business.

The company valuation methods can be followed to the letter or they can be amended, adapted and tailored to each individual business and this is without a doubt, the best way of how to value a business.

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