Whether you’re buying or selling, it’s good to know the underlying methodology behind business valuations. Ultimately, a business will be worth what another person or party are willing to pay for it. Many factors can help bump up (or down) the fair valuation of a business. In this article we’ll explore some of the actual factors that can go into determining business value.
It’s worth remembering that SME’s, in theory anyway, ought to be somewhat easier to value than larger corporations – as they mostly will have a simpler, clearer cut business structure.
Here are some things to keep in mind as you go about valuing your SME:
- Value A Business Depending On Profits Multiple. Ultimately, a business worth buying should ideally be chugging out a profit. One way to value the business is by paying a multiple of its profits, or earnings. It’s a little like applying the PE (Price to Earnings ratio) in share valuation. The PE ratio is the multiple of earnings that determines the price per share. So, if the earnings per share is say £1 and the share trades at £20 in the stock market, the PE is 20. So, investors need to fork out 20 times the earnings of each share to own it. Of course, in the stock market PE can be anywhere from low single digits to over a hundred. Typically, lower PE shares could be tagged undervalued, and high PE ones overvalued. The limitations of this model to value a business is that it does not take additional factors aside from earnings into account.
- Value A Business Based On The Underlying Assets. Possibly the fairest and most robust way to value a business is to tot up all the business assets that are squatting on the balance sheet, add in a value for goodwill and potential and arrive at a fair business value. Some of the business assets you’ll want to include will be IT hardware, machinery, equipment, real estate and anything else that is considered an asset. You may need to account for balance sheet liabilities that could be offset against assets if these are particularly high.
- Other Factors. There’s more that can impact a company’s value beyond the obvious. For example, don’t underestimate the value of goodwill. This is a conceptual value of the business – the worth of it’s reputation, longevity and the fact that it’s an established going concern with staff and customers and possibly a host of other stakeholders. The more successful a company is, the more its goodwill will be worth. A company could also be valued higher if it has exciting, unique features – for example a patented product or service that’s cornered a market and will continue to do so for years down the line, or a pool of talented employees that are noted to be among the best in the industry. Similarly, if a company has cornered a particular market or niche, this can be a huge selling point that a potential buyer may pay well over the sum of the parts to acquire
Ultimately, there’s no way to value a business with pin point accuracy. Emotionally, the hard work and sweat that an SME owner would have invested may well make them think it’s worth more – while a cold hearted businessman might well value it just below the sum of the parts to try and get a good value business at a bargain. Somewhere in the middle is most probably where the true worth of the business lies.