Valuing Businesses – science or art?
So is Business Valuation a science or an art? Our Virtual Finance Directors are often asked to help value businesses and this edition of Game Plans for Growth will examine the more common valuation methods normally encountered and when they should be used.
There are many reasons why a business valuation may be needed, including buying a business, selling a business or even organising a Management Buy Out (MBO). Business Valuations are also crucial when equity investment is sought, either from business angels or from private equity funds. Business Valuations also need to be negotiated with the Revenue for share valuations and the issue of EMI Share Options (please see our earlier newsletter on ‘How to retain key managers including use of Share Options‘).
It is helpful to review Business Valuation from the standpoints of Buyer or Seller:
From a Buyer’s perspective the first consideration is the size and profitability of the target business. If the target business is not yet profitable or at break even, then a Net Asset Value basis may well be appropriate. Net Asset Value is the realistic value of each asset category, less liabilities, at a given point in time; more details on calculating Net Asset Value.
Assuming the target business is profitable, then the Profit Multiple method is more likely to be appropriate. The Profit Multiple concept might appear simple, however care needs to be taken on which level of Profit (Pre Tax, Post Tax or even Earnings before interest tax depreciation and amortisation (EBITDA)), and whether this applied to historic figures or future figures.
The Buyer may also use the Payback Period method, when the target’s future Profits are forecast and the payback period calculated according to how many years and months it will take to repay the investment (including deal costs).
More sophisticated methods include Discounted Cash Flow and calculating the Internal Rate of Return (IRR).
The Seller will normally seek to sell on a Profit Multiple, and preferably a future Profit Multiple. However if the business has a higher asset level than would normally be expected for the type and size of business, then the Profit Multiple method may also be combined with the level of ‘Excess Net Assets’ to achieve the best overall value.
The Business Owner selling his or her business will want to maximise the exit value, and this is best done through thorough preparation of the business and a professional confidential business broking process. Our earlier newsletter on ‘what Buyers look for’ provides more information on how to prepare a business for sale. Please email me if you would like our free factsheet on ‘Top 10 mistakes in preparing your business for sale’.
The End Result
So is valuing a Business an art or a science? The methods described above could all be described as sciences, however the choice of method and further assumptions made imply more of an art. In any event, the ultimate way of determining the true Business Value is what a willing seller will sell for and a willing buyer will buy for! If you would like to organise a Business Valuation then please contact us.