How much is my company worth?

Get rich quick merchants feed off every business sector.  One of the most common approaches comes from those offering to value your company and then sell it for you.  Like Estate Agents, the reality of the outcome is not always quite what you expected.  On top of that, if you are not careful, you can spend a lot of money without actually getting much further forward in the process of selling your business.

The valuation process

Don’t be blinded by the mysterious jargon of EBITDA, P/E multiples and the rest – the valuation principles really are very straightforward.  Remember: all you are trying to do is give a little scientific backing to what is a very simple proposition – a business is worth as much as the purchaser is willing to pay and the seller willing to accept.

But you do want to be happy that this price reflects the quality of the business, its assets and its future profitability.  The “experts” will mention at least four different valuation techniques, but only the last of these normally applies:  

Comparison with stock market valuations

The concept is simple:  look at the price:earnings ratio of similar companies listed on the Stock Exchange and apply the same multiple to your company’s earnings.  This technique rarely gets to first base because there are no comparable businesses to yours’ listed on the Stock Exchange without making some rather wild adjustments or assumptions, so let’s move on to:

The dividend yield 

This can be a useful indication in some circumstances (especially for minority shareholdings) but the simple fact is that in private companies dividends invariably reflect the personal needs of the shareholders and have nothing to do with the underlying profitability of the business.  

Next we have

Net assets or break up basis

This has much more universal application because whatever valuation you calculate on any other basis, you don’t want to sell a business for £x when you could get more by simply shutting the doors and selling off the assets.  So it is a useful benchmark but don’t forget that simply closing down can involve other costs:  redundancy for employees, stock/debtors rarely reach book values on a forced sale and selling a property at an acceptable price may entail a long wait.

Earnings basis

The most reliable and accurate technique, it involves just three steps:

1. What are your maintainable profits?  Look at the last three years’ results, strip out the one offs (e.g. big bad debt), adjust your own remuneration to a sensible arm’s length figure, take the average and you have the answer.  

2. Decide on a multiplier. For a small private company, this will typically be between 2 and 8.  Also known as the capitalisation ratio, it is the number of years of maintainable profits worth paying to acquire the Company’s profit stream.   A low multiplier reflects a company with few customers, of poor quality, in a business sector in decline or where new competitors can easily emerge.  A high multiplier reflects a company with a wide spread of quality customers, a strong USP and so on.

3.  Assume maintainable profits of £100,000 and a multiplier of 5 and a sensible starting point for agreeing the selling price of your company is £0.5m.

Easy wasn’t it? And not worth paying tens of thousands for someone to do it for you.