Determining a valuation for a business is frequently a key factor in the initial considerations for exiting business owners. Understanding what the market may consider a reasonable price for the business may influence the type of transaction undertaken and indeed whether you are willing to sell, seek investment or otherwise exit the business.
This guide seeks to explain the types of valuation that may be used in determining a market value when selling your business.
Enterprise Value or ‘Price to earnings ratio’
Most often in sales or investments an ‘enterprise value’ or ‘price to earnings ratio’ is used to value a business. This way of valuing a business takes the profits of a business and seeks to determine an appropriate ‘multiplier’ of that figure to land on a price.
For example, using a price to earning ratio of five for a business that makes £500,000 post-tax profits would mean that the business would be valued at £2,500,000.
Determining what the appropriate ‘multiplier’ will be is often tricky. Many factors will contribute to the analysis of this. Certain business sectors, such a tech start-ups, have higher multiples due to the level of rapid growth expected in these sectors. En vogue sectors similarly carry higher multipliers, as an example, we are seeing (2022) good multipliers for ecommerce and professional services sectors.
Proven annual profits can also realise a higher multiple. Investors will also give higher multiples to those business in which they can see scalability. Also known as a ‘buy and build’, private equity investors will pay higher multiples for those businesses they believe can be grown quickly and then sold again, ultimately making a profit for the private equity fund.
Asset value
A very straightforward way of valuing a business is to allocate it as price based on the assets it owns. This is a calculation on the actual value you could realise for the assets in the business less it’s current liabilities. Whilst this is easy for tangible assets such as stock, property and vehicles, difficultly comes where intangible assets are key to the business. This may be things such as reputation, know-how and key employees.
Discounted cash flow
On the other end of the scale this is a complicated way of structuring a valuation. This valuation method is used to estimate the value of an entire company or an asset by predicting its future cash flows and discounting them back to their present value. This technique is used in finance and investment analysis because it focuses on intrinsic value - what the company is fundamentally worth based on its ability to generate cash. However, as this method relies heavily on complex forecasting and can therefore be challenging to establish.
External factors
The value of a company is influenced not only by its internal operations and financial health but also by a wide range of external factors. These factors can impact a company’s ability to generate revenue, control costs, and achieve growth, ultimately affecting its valuation. We see large fluctuations based on a number of factors including:
- Economic Environment: Factors like interest rates, exchange rates and general UK fiscal policies.
- Political and Legal Environment: Government regulations, including tax policies, upcoming elections or legislative changes.
- Market and Industry Conditions: Shifts in industry trends, such as technological advancements, consumer preferences, or market saturation.
- Supply Chain Dynamics: Disruptions in the supply chain, such as shortages of raw materials, logistical issues, or changes in supplier relationships.
- Social and Demographic Factors: Changes in consumer preferences, spending habits, and brand loyalty
- Technological Environment: Rapid technological advancements.
- Environmental Factors: Climate change and sustainability and ESG (environmental, social, and governance) concerns.
Valuing a company is a complex process that requires careful consideration of the various methods available, each with its own strengths and limitations. The choice of valuation method depends on the specific circumstances of the company, its market and your own personal drivers.
Wright Hassall are experienced legal advisors in relation to all types of exit strategy, if you are considering selling your business, we would love to hear from you to discuss your options in detail.
The information provided in this article is provided for general information purposes only, and does not provide definitive advice. It does not amount to legal or other professional advice and so you should not rely on any information contained here as if it were such advice.
Wright Hassall does not accept any responsibility for any loss which may arise from reliance on any information published here. Definitive advice can only be given with full knowledge of all relevant facts. If you need such advice please contact a member of our professional staff.
The information published across our Knowledge Base is correct at the time of going to press.
