FinancesHow to value a small business

How to value a small business

How do you value a small business? Business valuation involves working out the monetary worth of a business and, if you’re thinking about buying or selling your business, looking at raising finance or investment, or planning business growth, then you need a clear understanding of your business’ valuation.

What is a business valuation?

A business valuation is the process of working out how much a business is worth if the company were to be bought or sold. Most often, the valuation is calculated because a business owner wants to buy or sell their business, but it might also be as part of a process to raise finance or for tax or inheritance reasons or if there company is struggling and considering bankruptcy.

The importance of business valuation

A business valuation provides a clear and measurable value of the business’s worth, which is necessary for various business transactions, such as the sale of the business, securing a loan, or bringing in new investors.

For example, if you are considering selling your business – or your part of a business – then you need to work out the business valuation as part of your exit strategy from the company. An accurate valuation gives a tangible and realistic view of your business’s worth in the market and lets you negotiate a realistic price that is fair to the buyer and seller.

Methods of valuing a small business

Determining the worth of a business can be complex and there many different ways of working out the value, each method having its own strengths and weaknesses. Here are some of the most common methods used to value a small business:

1. Net Asset Valuation (NAV) method

The Net Asset Valuation method is a simple calculation based on your tangible assets. These assets include physical items like premises, land, machinery, and stock. To work out the value based on your net assets, calculate your assets minus your liabilities. However, this method doesn’t consider intangible assets like intellectual property, trademarks, patents, and brand.

2. Earnings Multiples method

The Earnings Multiples method, also known as Price/Earnings (P/E) Ratio, compares the price of your company shares versus your company earnings. This method is commonly used when valuing new or early-stage companies that lack sufficient earnings history.

3. Discounted Cash Flow (DCF) method

The Discounted Cash Flow (DCF) method aims to work out what the future cash flow would be worth today. It’s a complex formula based on the assumption that £1 today buys more than £1 tomorrow because of inflation. This method is typically used by established businesses with stable and predictable cash flows projected for the coming years.

4. Entry Cost method

The Entry Cost method shows how much it would cost to build your business from the ground up. Consider costs including start-up fees, recruitment and training, tangible assets, development of products, marketing, and more.

5. Price-to-Earnings (P/E) Ratio method

The Price-to-Earnings (P/E) Ratio Method, also known as multiples of profit, compares the price of your company shares versus your company earnings. To do this, you simply multiply your profits by the ratio figure, which could be anything from two to 25.

6. Industry Rule of Thumb method

Some industries have standard ways of calculating business valuations. It’s a good idea to find out what’s considered standard for your industry, as you’re likely to be questioned about this figure.

7. Business valuations using EBITDA

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation) is another commonly used metric for business valuation. This method provides a clearer picture of a company’s operational profitability by excluding non-operating expenses.

8. Valuing Intellectual Property Rights (IPR)

Intellectual property rights (IPR) like patents, copyrights, and trademarks can significantly add to a business’s value. It’s vital to accurately evaluate these intangible assets to get a full understanding of your business’s worth.

Factors affecting a valuation

There are many factors that can drive up or down the value of a business including those inside the business (for example, the amount of stock, types of customers, if the products or services are unique) as well as external factors such as the current economic climate. When considering selling your business, it’s sensible to include or estimate the effect of such external factors when coming to a final valuation.

Getting professional help

While business owners can undertake a basic business valuation, it is often a good idea to speak with a professionals, such as an accountant or business broker, who is experienced at valuing businesses and their assets. Getting advice from a professional will help you understand the elements of the valuation, what is driving it up (and down) and help you get an accurate and fair calculation of the value.

Summary

Valuing a small business in the UK involves a blend of financial analysis, industry trends, market conditions, and a bit of art. The methods mentioned above are commonly used in the UK and can provide a reasonable estimate of a business’s worth. However, it’s always advisable to get professional advice to ensure you get the most accurate valuation possible.

Whether you’re planning to sell your business or seeking new investors, understanding your business’s value is key to making informed decisions. So, take the time to understand these methods and consider seeking professional advice to ensure you get the most accurate valuation possible.

Written by

Anna Thornhill
Anna Thornhillhttps://gosmallbusiness.co.uk
Anna Thornhill is one of our expert writers. Anna is our specialist editor covering business growth and marketing and makes it her mission to provide small business owners with practical guides that help you step-by-step to grow your business. Anna’s an experienced sales and marketing professional who moved to writing and editorial and helps startups and small business owners with practical advice in growing their business with the latest sales and marketing techniques plus guides to choosing and using sales and marketing technology.

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