With the launch of the new series of Dragons’ Den we thought we’d tackle one of the key mistakes that so many of the entrepreneurs make – over valuing their business. Business valuation is not an easy task and involves many assumptions and variables, but to help you get started here are our 5 top tips to help you find a realistic value for your business:
Valuing a business based on forecast profits or cash flows can be a useful valuation method. However, if the forecasts on which your valuation is based are unrealistic or not reflective of the actual trade then your valuation is meaningless. Really think about the assumptions that underpin your forecast figures – how will you achieve these? Do you have sufficient costs included to increase revenues? Do you need any capital expenditure? Have you included a contingency for unexpected costs?
Future investors will not pay for value that they are going to help create. If you need cash to grow the business, do not include this in your current valuation. Investors will only pay for what the business is worth today. If investors paid the future value of the business there would be no profit in it for them, so be sure to focus on current value.
Listed entities in the same industry can provide useful data in terms of comparable Price Earnings multiples, but always remember that private companies will always be valued at a discount to similar listed companies due to the lack of marketability of private company shares. For example, if a listed retailer is valued at a P/E multiple of say 10, a private retailer may only be valued at a multiple of 7. A discount will always be applied.
Many things can effect the risk profile of your business and these will all effect value. Therefore, always consider where your business is more or less risky than other businesses. For example, start-ups are higher risk than more established businesses, businesses with long term customer contracts are lower risk, some industries are higher risk (such as the tech industry or those with low barriers to entry), reliance on a few key customers or suppliers may increase risk. Always consider specific aspects of your business that may increase or decrease value compared to other similar entities.
Never value your business based on financial information that is not representative of a normal trading year. If you had an exceptionally good year or incurred some exceptional costs in a year, valuing your business based on these figures could result in an over or under valuation. Potential investors want to understand maintainable earnings – that is typical profits excluding any exceptional costs or income. Adjustments should be made to bring in an ordinary level of costs. If, for example, directors have taken dividends rather than salaries, adjustments should be made to show how the profits would look if normal directors’ salaries had been taken. This allows investors to see how earnings will likely look following their investment and allows them to compare the company to others on a like for like basis.
Business valuation is a very technical area and if you want to understand the true value in your business it is always worth taking advice. HW Fisher are experienced in undertaking business valuations (both share valuations and trade and assets) so do get in touch if you would like to discuss your business.