If you’ve built a business from scratch, you know the countless (and probably often thankless) hours you’ve put into getting it off the ground.Of course, your business is priceless to you and you can never really get everything back that you’ve put into it. But at some point, you may consider selling your business in order to get capital to build another one, to have money to invest or to use the funds for retirement.
But how much is your business currently worth? How much could you sell it for if you wanted to?
Ideally, you’ll sell your business at a time that’s most advantageous to you, when you’re prepared and ready to sell. You don’t want to sell in a hurry, when you really need the money or when there’s an economic downturn that could lower the price.
There are a number of free and paid online calculators to help give you a sense of your business value, and you will need to work with a professional financial advisor to get a realistic value estimate. But first, take a look at these critical factors yourself.
Valuation methodology
There are a number of ways to value a business, including:
- Capitalisation of maintainable earnings
- Industry valuation
- Net tangible assets
The most common method is based on the capitalisation of maintainable earnings. This method takes the following into account:
- Maintainable Profit
When someone buys your business, they want to know your profit and everything that goes into achieving that number. They’re not as interested in how much revenue you have – you can’t live on revenue, and as a great client of ours often says, “It’s not about the turnover, it’s the leftover that matters”.
A buyer will appraise your historical profit – excluding non-business and extraordinary items – to determine what they believe the business’ true maintainable profit to be.
- Risk and Growth
After making an assessment as to the sustainability of the business profit, a buyer will consider their own ability to grow this profit. They’ll look at historical revenue, profit and cost structures to confirm relatively riskless future profit, and then look at revenue growth to determine whether there’s much blue sky to be found. These factors all play a part in determining the risk of the purchase.
Risk is reflected in the capitalisation rate a buyer will apply to the maintainable profits. The higher the risk, the higher the capitalisation rate (the inverse of which is a multiple of maintainable profits). A high-risk business might attract a 50% capitalisation rate, which equals a profit multiple of 2. A low-risk business might attract a 20% capitalisation rate, which equates to a profit multiple of 5.
- Debt
Many businesses have some form of debt, including overdrafts, core bank debt, hire purchase facilities on plant & equipment, and so on. This debt comes off the value calculated from the capitalisation of the maintainable earnings. For example:
- Maintainable earnings $1m
- Capitalisation rate applied 20%
- Business value pre debt $5m
- Debt $1.5m
- Value of the business $3.5m
This business value includes ‘all things required to carry on the business’ including all plant & equipment, inventory and work in progress, as well as any patents or copyrights you may have.
In bigger business sales, these assets are included, which means you won’t get paid extra for them as they’ll be included in the sale price. As such, their market value doesn’t matter much.
Sometimes in smaller business sales, these assets are added on top of a ‘goodwill’ valuation – this is a mix of valuation methodologies that isn’t strictly textbook but does occur quite often!
Finding out the value of your business and how you compare to competitors is especially important if you’re thinking about selling your company in the next few years. Discover how using our free tools below – they will help you create even more value in your business.
