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How to Value a Company

If you are considering selling a business then you may be interested in how to value a company and in particular how to value your own business.

At a very fundamental level this is easier than you might think. Basically, you set a price and if someone is willing to pay that price then, bingo, the sale is made.

Company ValueThe problem, of course, is that, even if you pick a random figure from the air as a sales price, the purchaser is likely to be looking for some logical justification for that price. It has to make logical sense either in terms of purchasing a place in the market, or at least in terms of an expected return. For example, a business may be bought for a sales price of £500,000 on the basis that it will make an after tax profit of at least £50,000 each year – a 10% return. This is probably quite a bit more than an investor might get back from putting the money in a bank account, but arguably quite a bit less than they might gain on the share market during a good bull run.

The added effort and stress that often goes with running a business surely must make it a less attractive proposition than a judicious share market portfolio in a rising market, so why would a purchaser bother?  This is a question that needs to be answered in both how the business is presented to the market and in its valuation. The logic behind the valuation is therefore important and forms part of the overall sales package being offered. A business may well give a particular return on a given turnover, but we may also consider the potential the business represents: its share of the market overall; the potential for growth; its relationship to the buyer (perhaps it is a competing business).

A purchaser may also be looking to enter a market, perhaps as an extension to an existing business. In this scenario a higher sales price may be justified on the basis that the cost to the purchaser would still be significantly below that required to enter the market from scratch. The sale of an existing business with a good reputation to another business, with a good reputation in another connected market, may also produce a final result for greater than the sum of the parts.

Having said that, statistics show the average sale completion figure is between 1.8 and 3.1 times the net cash profit (before depreciation, capital finance cost, the owner’s remuneration package, and any costs of replacing the owner in the business). You can see the purchaser’s arguments in such figures, but we have also known a new start business be sold for £130,000, before being bought back at a later stage by its original owner for £10,000 eighteen months later.

Ultimately the logic of the sales valuation is in the relationship between the core business and what it has to offer and the perceived worth on behalf of the purchaser. Therefore, it is worth asking the price you consider an ‘ideal’ purchaser will pay and working back from that point.  The sale will take many months to complete and will be subject to numerous minor negotiations along the way, if the original asking price is not high enough you will have nothing to negotiate with.

In our experience the logic potential business sellers often apply to their sales price does not always bear scrutiny. Certain aspects of the business may be over valued, but other important areas under valued, or even completely ignored. Sometimes in the forest it is difficult to see the wood from the trees.

It is for this reason that the independent advice provided by A2Z Business Brokers can be so valuable and if you want to know how to value a company because you are thinking of selling your business we would urge you to get in touch for a no obligation, free, initial consultation.

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