If you are looking to sell or buy a business, it is critical to know what the business is worth. A business is an evolving and changing entity, that is generally affected by fluctuations in the market share, the economy and management. Determining the value of a business is a lengthy process that needs careful consideration. It is not as simple as looking at what a similar business sold for and selling for a similar price. Every business is different and unique. The biggest challenge is that both parties – the buyer and the seller – usually have two different figures of what they think the business is worth. Therefore, to help you understand the business valuation process better, here is our complete guide on how to value a business for sale.

What is a business valuation?

Business valuation refers to the formal process of estimating the present value of your business. If you are planning on selling your business, you want to ensure that your asking price is attractive to prospective buyers whilst also ensuring that you don’t leave money on the table.

Factors influencing how you value your business for sale

A myriad of common factors needs to be taken into consideration throughout the valuation process. These include:

Assets

Assets add value to your business. Tangible assets such as property, equipment and stock, will enable your business to leverage them to secure immediate funding if required. However, if your business only holds intangible assets, your business will be relying on future profitability as the driver for a positive business value. Intangible assets include customer goodwill, intellectual property, business growth potential. These assets are more difficult to value.

Length of Time

The longer your business has been operating, the better. This will act as a proven track record to show that your business is stable and insusceptible to current popularity where the market later turns away. Additionally, the length of time your business has been operating will assist in understanding how your business has grown in the last few years.

Cash Flow

This factor requires you to consider: What is your annual turnover? How reliable is your cash flow? How much has your revenue grown in the last few years? Significantly, a business that has strong cash flows and reliable profit projections offer serious potential in value for prospective buyers.

Industry Outlook

This factor looks at how much potential the industry has to grow in the future. Therefore, positive industry growth and competitive fragmentation improve a businesses’ growth trajectory and will have a positive impact on value. If an industry is booming and trending towards your business, the higher your multiplier will be. On the other hand, a saturated industry with many similar businesses may decrease the valuation of new entrants.

how do you value a business for sale

Common methods of how to value your business for sale

Income Based Business Valuation

The income approach attributes value to a business based on the present value of its future cash flows or earnings. There are two ways you can utilise this valuation method:

The Capitalisation of Earnings Method

This approach calculates your business’s future profitability through consideration of the business’s cash flow, the annual rate of return, ROI, and expected value. Therefore, to do this divide the historical total cash flow stream of a business by its capitalisation rate. The capitalisation rate reflects the riskiness of a business and its expected growth in the future. The income method can be utilised when future growth rates or margins are expected to vary. As well as when modelling the impact of debt repayments in future years.  

The Discounted Cash Flow Method

This approach is done by calculating the present value of the business’s projected future earnings, plus the present value of the terminal value. In particular, the amounts of projected earnings and the terminal value are discounted to the present using an appropriate discount rate. This approach is most effective for businesses with high-growth potential, but are not at present profitable. The difficulty with this approach is it is relatively difficult to predict the future.

The degree of estimation involved in calculations is the main drawback of this method to value your business for sale.

Asset Based Business Valuation

This method of business valuation relies solely on the assets of a business and deducts its liabilities. This approach requires an analysis of the economic worth of the business’s tangible and intangible, recorded and unrecorded assets. This method addresses the book value of the business. This method is relatively straightforward. However, it frequently yields the lowest value and is commonly used to establish a floor for the value of your business. There are two methods that you can use for valuing a business using the asset approach:

An Ongoing Concern

This approach looks to the business’s balance sheet. The business needs to list out total assets, and subtract its total liabilities, giving you the ‘book value’ of assets.

A Liquidation Value

This approach determines the liquidation value or the net cash that would be received if all assets were sold and liabilities paid off.

One of the greatest difficulties in using this valuation method is the adjusting of the net assets. The adjusted asset-based business valuation aims to determine the current market value of the business. Whereas, balance sheet appraisals employ depreciation to diminish the asset value over time. As a result, an asset’s book value is not always the same as its fair market value.

Market Based Business Valuation

The market valuation method determines a company’s value based on the purchases and sales of comparable companies. This is one of the more simpler business valuation methods. To follow this method you will want to focus on finding similar financials within your industry and then calculate the average of valuation multiples. This method uses multiples as an easy way to compute a company’s value to compare against. The multiples commonly used are return on equity, price to earnings, EBITDA, price to book value, and return on assets. The two most common approaches to market valuation are:

Public Company Comparables

In this method, you review the data involving sales of ownership interest in publicly traded companies that resemble your business. The greatest drawback of this approach is public companies are not only larger but often more dissimilar to your business. Similarly, the process of choosing, adjusting, and applying public company valuation data is usually difficult and requires substantial experience. Nevertheless, the public company comparables approach can be used to value a business relatively efficiently. Public company financial reporting data is readily available and generally reliable.

Precedent Transactions

This approach focuses on deriving value using pricing multiples that are based on sales of companies in your relevant industry. However, an impediment is that previous business sales may be significantly different to the current market or industry conditions.

When choosing to follow either of the above approaches to market based valuation, it is imperative to select a company that is vastly comparable. This involves considering the following factors:

  • Are they operating in the same industry?
  • Are they similar in size?
  • Do they offer similar service or product offerings?
  • Whether they operate in a similar location?
  • Do they have similar profits?

The predominant challenge with this method is acquiring sufficient market data to compare your business to reach a reasonable valuation. Therefore, for this method to value your business for sale to be successful, it is critical that the business’s being used for comparison are similar to your business or that there are discounts or premiums applied for varying features.

Tips on successful valuation

As discussed in our previous blog on the Top 5 Tips on How To Value a Business, one noteworthy tip is to seek the advice of a reputable business broker. Choosing to engage a professional when valuing a business can increase your credibility and reduce the complexities of the entire process. Valuing a business is a relatively complex process that requires a multilayered approach. It is important when considering how to value a business for sale that you consider getting expert advice or doing extensive research.

Here at BUSINESSNAV, we are committed to helping you navigate through the business valuation and sales process seamlessly. Contact one of our business experts using the form below: