What is the value of my business? … This is a very common question we are asked as Business Advisers and one that requires a high level of skill and experience to answer, it is also one that would be asked more often depending on the outcome of the proposed CGT (capital gains tax).
You can value a house based on its condition, its location, the number of rooms and the amount comparable properties have sold for. You can value a painting on the reputation of the artist, the quality of the painting and auction prices for similar works.
But these are tangible values and, while most businesses have things that can be discreetly measured there are many intangibles too, from copyright and intellectual property to brands and patents, and many other business assets that can add to a company’s value.
Suffice to say, there is no simple formula to determine the value of your business. Valuing a business is a very difficult calculation for any valuer to make unless market conditions are perfect – that is, where there is a true market base with buyers and sellers regularly entering into similar transactions.
However, markets are volatile. So getting an accurate valuation of your business relies on choosing a skilled valuer – someone with the ability to combine knowledge and experience with application of valuation principles to come up with an ‘opinion’ on the value of the business.
To give you an idea of what is involved, following are some of the key accepted principles a valuer will use:
A hypothetical marketplace
Here, the valuer considers the valuation in terms of a willing, but not anxious seller and willing, but not anxious buyer, with both possessing similar facts and in friendly negotiation.
A business’s value is determined by the income stream it will generate, either from the profits/cashflow of the business or from the ultimate realisation of the assets of the business. Determining the future maintainable profits (FMP) of the business is therefore a critical component of the valuation process. To determine the FMP the valuer must not only look at historic events, but look at trends to provide a guide to the future.
Once the FMP is determined the valuer must determine an appropriate multiple to apply to it. The multiple represents the risk profile of the business. The lower the multiple the higher the risk profile of the business. As an example there may be two businesses which generate a profit of $200,000 per annum. Business A could have a diverse customer base, a strong management team and good reputation in the marketplace, while Business B could be heavily reliant on one customer and only have traded for a year. A prudent purchaser would be prepared to pay a greater price for Business A than for Business B. The multiple applied to the FMP of Business A would therefore be greater than Business B.
Underlying business assets
Having considered the FMP and appropriate multiple for the business the valuer must then consider the result in light of the underlying assets of the business. If a figure results in a value significantly less than the underlying net tangible assets of the business, the valuer should then consider the merits of a notional liquidation valuation. Whereas if a figure results in a value significantly higher than the underlying net tangible assets, the valuer should consider the level and appropriateness of the resulting goodwill element.
Despite these principles, the valuation of any business/ company is actually more art than science. It requires the ability to take into account all surrounding business facts along with knowledge of the sector, precedents and risks – all while making judgment calls along the way.
Quite simply, if you’re after an accurate assessment of the value of your business – make sure the valuer is experienced.