How do I know what my business is worth?

There are several different ways to work out what your business is worth and it is important to remember from the outset that valuation is often more of an art than a science. Depending on the circumstances of the business, some valuation approaches may be more appropriate than others.

Broadly speaking, the different valuation techniques are:

• The market multiple approach

This is the most common valuation technique and typically applies appropriate multiples to an estimate of the future maintainable earnings of the business. Historically, a price multiple has been applied to future earnings after interest and tax. Alternatively, multiples of future earnings before tax, or earnings before interest and tax can be used.

The estimate of future maintainable earnings should be based on a reasonable forecasting period. The multiple to be applied to this estimate is normally established by referring to comparable quoted companies and the multiples used in acquisitions and disposals of similar businesses.

Adjustments should also be made, where appropriate, for items of a non-recurring or exceptional nature which may have been included in the most recently reported earnings.

The main problem with market multiples occurs when adjustments are made to reported multiples to reflect the individual circumstances of specific businesses. Such adjustments are entirely ad-hoc and subjective, rather than the result of any agreed methodology.

• The Discounted Cash Flow (DCF) approach

This is the most theoretically sound method of valuing financial assets. It focuses on cash generation and takes into account future changes in the business’s operating environment.

The approach converts the sum of the future cash benefits of ownership into a single present day value by discounting future post-tax operating cash flows by a risk-adjusted rate of return. The higher the risk, the greater the discount and the less the future cash flow is worth in terms of today’s cash.

• The dividend yields approach

A company’s dividend yield is simply the ratio of its dividends to its value. Dividend yield valuations are most commonly used to value shares in companies, such as utilities, in mature markets with strong cash flow but poor growth prospects.

An estimate will need to be made of likely sustainable future dividend growth. Fortunately, dividends tend to be more stable than earnings and are unlikely to require as many adjustments.

The yield to be applied to future dividends is established in the same way as with market multiples. Similarly, adjustments to these yields to reflect individual company circumstances tend to be ad-hoc.

• The net asset approach

Net asset valuations are generally used as a valuation tool on break-ups, or in the property and investment trust sectors. However, a net asset valuation may be used as a benchmark in other methods of valuation.

The valuation of assets is of little use in valuing businesses where much of the value is tied up in goodwill, such as brands. In these cases, a discounted cash flow method or market multiple method will be more appropriate.

The greatest problem with asset-based valuation techniques is the widely differing valuations that can result from different assumptions about the likely nature of any asset sale.

All valuations will contain assumptions and estimates so it is often useful to check the results of one method against the other.

It is also important to remember that a business is only worth what somebody will pay for it and market multiples are not set in stone.

For more information on selling your business, or help with any other matter relating to mergers and acquisitions, contact our Corporate team on 01772 258321.