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How to Value a Business

If you are thinking of selling your business, the obvious first question you will need an answer to is ‘what is it worth’?

Valuing a businessThere are lots of theoretical approaches and practical methodologies relating to how to value a business, often based on a return on capital invested model. Usually past trading is used as a basis for future projections, but in recent years we have seen this careful approach abandoned for internet based models that can show (theoretically at least) exponential projected growth paths.

Of course, ultimately, it is worth what a seller will accept. For certain owners this can be as low as a nominal fee if the sale is being made to protect the employment of loyal employees and the owner’s future has been secured by other means.

Other approaches can be centred on multiples of the turnover, but in many ways it can be almost a whimsical amount. In the final analysis, you can ask for whatever you like and if someone is prepared to pay that fee, then the sale can be made. Obviously the higher the fee you ask the longer you may wait for the right buyer – a bit like selling a house.

When external finance is required by the prospective purchaser, we then see the financiers determining additional decision criteria with respect to the investment. This generally means the financiers will require some sort of security. This is fine for highly capitalised industries such as engineering and other manufacturing. However, it is bad news for service industries where the ‘capital’ being purchased is more likely related to goodwill and brand identity.

If the business being sold also has some strategic positioning in terms of either the overall market, or the physical location, an additional fee can often be demanded and purchasers may well be willing to pay it to secure the position. We saw this recently in the ridiculous fee paid by Facebook for Instagram. This was not about past, or even future earnings, it was about securing the place in the market that Instagram had found.

Back in the physical world, at the time of writing, Little Chef is up for sale. Ordinarily this poorly performing brand would not bring a high price, however, the prospective buyers do not want the brand, they want the physical locations that the restaurants occupy. We can expect Little Chefs to be turning into MacDonalds, KFCs and Starbucks in the not too distant future. The strategically attractive locations the existing Little Chefs occupy will demand a higher sales price than a theoretical pricing just based on bricks and mortar alone.

This is known as an ‘opportunity premium’ and it can be applied in various ways and at various levels. For even a low capital, easy entry, business the ease of buying an existing business with a known location and profile is worth a premium just so the new owner will not have to start from scratch.

This is different from ‘goodwill’ which is the good name a business may carry and the repeat business that comes with it. For that, we may ask a little more.

Beyond the subjective factors outlined above other, more practical, considerations centre on how well the business has been run and how easy it will be to take over. A business that goes into meltdown every time the owner goes on holiday may not prove to be a good investment. However, if the owner spends an inordinate amount of time of the golf course, but the business is still thriving, then the entity is much more likely to be saleable and at a good price.

The deciding factor between the two relates to control and where the control of the business is centred. If control is centred on the business owner its future is precarious. If day-to-day control of the business lies within its procedures and delegated to a management layer then, strategic issues aside, the business is a stand alone, saleable entity.

How to value a business really is an extensive subject and by no means exhaustively covered here. Every business is different, as is every purchaser and ultimately every purchase.

It is minefield, in fact, and trying to negotiate it alone, especially if you have never undergone the process before, may well result in unhappy consequences. At A2Z Business Brokers, we have extensive experience of this particular minefield and lots of war stories to tell.

If you are trying to value your business because you are thinking of selling up, then talk to us first to make sure you get the maximum possible return on the sale – or fill out the form on on this page and we will contact you.   

See also: Valuing Assets

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A 2 Z Business Brokers Ltd
Suite A01, The Long Lodge,
265-269 Kingston Road, Wimbledon,
LONDON, SW19 3NW

Tel: +44(0)208 819 3538

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