If you’re looking for investment into your business, to take a loan against it or to better understand how it’s performing, you need to know how to value a business.
It’s especially common for new business owners to need to value their business. This is because potential investors will want to know what they’re buying into and banks will need to know how well positioned you are to pay back any loans.
If you’re a follower of the show Dragons’ Den, you’ll know how catastrophic a bad or incorrect valuation can be to an investment pitch! Here, we’ll explain how to value a business.
Methods of valuing a business
There are various methods you can use to value your business. These include the following.
Multiply your profits
One common valuation method is to multiply the current profits of the business. This method is best for businesses that are currently profitable.
To do this, you need to know what your current profits are. The business may be affected by seasonal fluctuations or one off purchases that aren’t typically replicated. By removing these one offs and standardising across the year, you can find out your average profit per month.
You can then extrapolate this by adding in any future costs your business is about to incur (i.e. a new premises or staff hires) and then work out based on your growth projections and percentage profit how much you expect to make for the rest of your financial year. This will give you an overall profit amount for the year.
You can then multiply this by between 3 and 5 times depending on the growth potential of the business. Smaller or younger businesses should err toward the lower end of this so as not to overestimate, though much bigger companies may have stronger projections that lead them to multiple by more.
You’ll be left with a value which, theoretically, should represent the total profit for the company in 3-5 years’ time, assuming all things are as expected. This can change depending on your business performance and other factors, so it’s worth updating your business value as and when you need it.
Value of assets
Another method of valuing your business is to look at the value of the assets it holds.
A business in the manufacturing industry, for example, is likely to hold a lot more in terms of assets due to the reliance on equipment, tools, warehouses, transportation and more. If you own a retail store, your physical shop and the stock within it are assets. If yours is an online business, the value of the domain is also an asset, particularly when you own a domain name that is sought after.
To value your business this way, you’d simply need to look at the total value of your assets, minus any liabilities. This will not take into account any inflation or deprecation and your assets should be valued at current market rate.
Barrier to entry
Some businesses have a higher barrier to entry than others.
For example, if you have a business that has a physical location and a good customer base, the cost of replicating that - buying the premises, marketing the brand, building the customer base - would be quite high. As such, a business which already holds those things may be viewed as more valuable.
If you had an online app based business, investors recognise how difficult it is to break into the app market and are likely to value your business more highly if there is proof that you have already built up a loyal fanbase.
This is a less tangible way of valuing your business, but arming yourself with information about the size of the market and the market share you currently have can be an influencing factor on the way your business is perceived.
Factors that affect the value of your business
The value of your business is affected by a number of factors including:
- Historical finances - how much money you’ve made so far
- Projected finances - how much you expect to make in the future
- Unique or protected products and patents
- Value of competitors - how much similar businesses are worth
- Value of assets
- Amount of debt
- Reputation in the marketplace
- Current marketing activity e.g. high search rankings and the quality of your website
What to do if you need to value your business
These methods provide valid ways of valuing your business. That said, if you have been asked to value your business for a specific purpose such as a pitch for investment or to take out a loan, you may decide it is beneficial to employ the services of an accountant to help you.
published under Management
