Valuing Your Business

Know your worth

While the most common reason for needing to value your business is its potential sale, there are many other reasons why you may have to carry out this exercise and it is important to use the best advice available and get it right.

Share valuations for tax purposes may be required for a number of reasons, including: when shares are sold or given as gifts; on the death of a shareholder; when there is activity in relation to trusts that gives rise to a tax charge; for capital gains tax purposes; and when certain transactions in companies take place, such as when the business buys its own shares.

Other reasons for a valuation include: when it is required by the companies Articles of Association; under shareholders' or other agreements; in disputes between shareholders; for financial settlements in divorce; when a shareholder is declared bankrupt or the business is declared insolvent; and when a business needs to raise equity capital.

Valuing your business can also help to motivate members of staff. You can use regular valuations as measurement criteria from which management can evaluate the development of the business. This can also be used to value shares for an employee share option scheme.

Listed public limited companies have a ready made market and market price for their company shares, so those wishing to value a private company need to look at the valuation methods open to them.

Earnings multiples are used to value a business with an established and profitable history. In many cases a price earnings (P/E) ratio is used. A challenge with using this method is in establishing the right P/E ratio to use. P/E ratios for quoted companies can be found in the financial press and one for a business in the same sector can be used as a rule of thumb. However, in reality the ratio needs to be discounted heavily because shares in quoted companies are much easier to buy and sell, making them more attractive to investors – in most cases, the P/E ratio of a small unquoted company is 50 per cent lower that a comparable quoted company.

Discounted cashflow is generally appropriate for cash rich, mature, stable businesses and those with good long-term prospects. The valuation is based on a cashflow forecast for a number of years hence plus a residual business value. The current value is then calculated using a discount rate to establish the value of the business in today's terms.

Entry cost reflects the costs involved in setting up a business from scratch, and is a method for valuation. The set up costs – purchasing assets, staff, development and other factors – are the starting point for the valuation and a prospective buyer may look to reduce this with any cost savings they think they can make. The asset-based type of valuation is best suited to businesses with a significant amount of tangible assets, such as an asset rich property or manufacturing business. This method does not take into account future earnings and is based on the sum of the assets less the business's liabilities. The starting point for the valuation is the assets as they appear on the accounts, which are then adjusted to reflect current market rates.

Good growth potential needs to be taken into consideration when valuing a business, as well as the influence of external factors and intangible assets, such as the strength of a brand and goodwill, licences held and the key people involved.

The circumstances surrounding a valuation will also have an affect on the final valuation itself – a business being wound up will be valued on a break-up basis and will therefore achieve less than a business that is being valued as a going concern.

As with all important business decisions and activity, it is best to seek the best advice you can afford before taking action.