Any business owner seeking growth will at some point have to answer the question: “What is your business worth?” It’s a tricky one, particularly when you’re an early stage startup without much in the way of evidence to work with. And even when you do, simple factors like net profit and asset value still only tell part of the story.
Coming up with a valuation that does your business justice but also has some basis, in reality, can be a complex and confusing process - particularly when you see your competitors announcing what seems like crazy numbers in the media.
But before you hit the panic button, you’ve come to the right place. Our Ultimate Guide will take you through everything you need to know.
When and why do you need to value your business?
A business valuation can be useful at any stage of your business journey, but you’re most likely to need one in the following circumstances:
- When securing investment. Most investors will want an idea of the value (or potential future value) of your business, to calculate the amount of equity they would receive for their investment, and also the potential for growth.
- When developing an internal share market. Knowing the value of your business will enable you to set a fair and competitive price for shares to be bought or sold by employees. It can also be used to inform shareholders and potential shareholders about how the business is performing.
- Stimulating performance and growth. A business valuation often forms an important aspect of a company review. Having a clear picture of how things are going for your business can help stimulate and inspire your team to bigger and better things.
- Selling your company. Should you ever want to sell your company, you need to know where to set the price tag.
What factors affect the value of your business?
There are a number of factors to consider when valuing your business and surprisingly few of them involve actual monetary values. At the end of the day, a business is worth what someone is willing to pay for it, and that can be a pretty subjective thing. So, don’t just pull out your accounting books – consider all the following when coming up with a number:
- Your brand’s reputation. Your reputation is one of your greatest intangible assets. If your company is well-known, well-respected, and/or has a lot of buzz around it, then you’re off to a very strong start.
- The value of your customer base. When assessing the value of your customer base, you should take into account things like customer loyalty, customer stickiness, and customer concentration. If your business is dependent upon a very few rather flaky customers, then your customer base value is low – no matter how much those customers may spend in one go. If, however, you have a larger concentration of loyal customers who are locked into your product, even if they’re not spending a huge amount, investors will sit up and take notice.
- The reasons you’re doing this valuation. Your value is related to how powerful your bargaining position is. If you’re valuing your business because you’re being forced into a sale, that will lower the ultimate value. However, if you’re valuing your business to seek investment and enhance a growth period, the ultimate value will be higher.
- The age and/or potential of your business. An older business with an established reputation and consistent profits may, on the face of it, seem more valuable than a startup. But don’t discount the value of potential. A new enthusiastic startup with a large potential market and a long life ahead of it may well be more valuable to investors than an established business whose product is less future-proof.
- The team behind your business. Your people are a really important part of your valuation. An enthusiastic, ambitious and skilled team, who are dedicated to propelling your business forward, will make a huge difference to your overall value.
- The strength of your product. This is related to the ‘potential’ factor mentioned above. A strong product, a strong model for delivering that product, and a growing audience engaged in that product, are all crucial for a good valuation.
- The numbers. Finally, the bottom line. How valuable are your assets? What are your profits? How hefty are your overheads? Factors like potential and a great team can mitigate small numbers here, but it’s important to pull out the pound signs in as much detail as you can nonetheless.
What are the most popular methods for valuing a business?
There are a number of different methods and markers you can use to value your business. We’ll go through some of the most common ones here:
- The Multiplier. On the face of it, the Multiplier sounds like a simple equation: Net Profit of Business X Market Sector multiple (the industry average for value vs. profits) = Business Value. In reality, there’s a lot to be careful about when using the Multiplier. It’s easy to fudge the figures, both net profit and market sector being extremely variable (depending on circumstances). For SMEs in particular, finding the bottom line for the multiples involved can be an obscure and bewildering process, the results of which aren’t always 100% reliable. Investors are aware of all this, which is why it’s vital to back up your multiplier figure with other evidence.
- Asset Valuation. Not all businesses are suitable for valuation based on tangible assets, and that’s OK. If you’re an SME or a startup with a lot of potential, that will work in your favour instead. However, if you are asset-rich, it would be silly not to take that into account when weighing your valuation.
- Entry Valuation. This one is pretty simple in concept. It involves working out the costs of setting up your business today from the ground up. It’s handy because it brings other valuation variables – assets and team members, for example - under its umbrella, but it is not so useful if an investor wants to focus on things like current profitability or future potential.
- Discounted cash flow. This is supposedly the method Warren Buffet uses to value businesses, so it’s got some top-flight endorsement. Be warned, however – it’s very complicated and is really only useful for heavily invested and well-established companies. Essentially, the method predicts future cash flow (based on current and past trends for the business) over designated periods of time (usually around 15 years). It then estimates what that future cash flow is worth today. An appropriate discount interest (typically between 15% and 20%) is applied to take into account things like risk and inflation. It’s certainly complex, relying on steady patterns and a stable future to work properly. So, probably best avoided if you’re not a multinational giant.
- Comparison. Comparison with the price of similar properties in the market is what sets house prices - and it works for businesses, too. If you can, check to see what similar businesses to yours have been valued at. This should at least give you a ballpark idea at the kind of figure you can realistically expect.
- Specific industry methods. Some industries have specific ways of measuring value, relevant to their own interests and needs. For example, retail businesses are often valued by the volume of customers or the number of outlets, while IT companies tend to be valued exclusively on turnover.
- Personal interest. At the end of the day, your business is worth what someone is willing to pay for it. Should you find an investor (or buyer) with a deep interest and enthusiasm for what you’re doing, the intangible value of your business rises enormously. So, think about where you’re ‘selling’ your business as well as how you’re valuing it.
Common pitfalls to avoid when valuing your business
Obviously, the biggest pitfall to avoid would be ‘don’t make it up!’ Pulling figures out of thin air will do you no favours. Anyone with experience in evaluating businesses can spot dodgy valuations a mile off. However, there are a few other less obvious pitfalls which you’d do well to avoid:
- Not considering business/owner dependency. It’s surprisingly common to neglect how intrinsic you yourself are to the success of your business. A great many SMEs fly on the vision and drive of their founders. A fantastic and integral founder is a great asset if you’re seeking investment, but if your business is too dependent upon you, this can negatively impact its valuation, particularly if there’s a chance that you might be leaving in the near future.
- Being over-ambitious. There’s a fine line to walk between displaying your enthusiasm and ambition for your business, and being realistic. Of course, it’s great if you’re really positive about your business’ prospects, but you do have to temper that with a modicum of realism. Investors don’t just want to see shiny ideas and an enthusiastic team. They also want to see that you have the commercial nous and grit to buckle in for the long term. That means demonstrating an understanding of the challenges you may face – which means being realistic with your valuation. Don’t undervalue, by any means, but do be aware that wild over-valuations will make you seem perilously naive.
- Being too numbers-focused. The larger and more established your business, the more important the bottom line becomes in valuations. But for SMEs and startups, it’s far from the be all and end all. There’s a lot more to a valuable business than columns of figures. As mentioned previously, future potential counts for an awful lot and the variables, which make your business a potential hit, are not numbers-based.
- Not being prepared to compromise. Depending on why you’re valuing your business, negotiation is likely to be a big part of what comes next. So, when undertaking your valuation, give yourself some leeway for compromise. Being inflexible is just as bad as being a pushover in business negotiations.
Valuing a business can be complicated, because so much of what makes a business valuable is hard to put a price upon. Your business is worth what somebody will pay for it, and that depends a lot upon the vision, the team, the potential, and how enthusiastically you sell the whole package. Having said that, a lot of the proof is in the pudding, so if you can roll out some nice, fat profits, or other numbers, that will definitely help your case!
While there are various points when you have to do a business valuation, it is often worth doing without a specific end purpose in mind. Calculating your value is an illuminating process, which will reveal your business’ strengths, weaknesses, best assets, and future potential in a way which less focused reviews can’t. Yes, it takes a bit of brain work, but it’s well worth the effort.
We wish you all the very best of luck!
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