Business valuations: how to value your company

An accurate business valuation could be the key to unlocking new investment into your company, helping you to safeguard its future and build for growth. Or, it could be your path to a company exit if you wish to sell your business in full at a price that reflects your years of hard work.

You might be surprised to discover how this proactive step can be a game-changer for your business, guiding you towards success and securing your financial well-being. 

In this article, we’ll explore the reasons why a business valuation might take place, and help you to consider your business’s worth even if you’re not looking to sell or raise funds immediately. We’ll also demystify business valuations and explore what they are, how they work, and why they matter for your business’s future.

Let’s dive in and explore the hidden benefits that await you when you choose to get a business valuation.

What is a business valuation?

Valuations are sought by various types of companies, ranging from startups to established firms. Regardless of the size of your business, understanding its value is essential. It’s like putting a price tag on your life’s work – the culmination of your dreams, mission and vision. 

A proper valuation can give you a clear and realistic picture of what your business is worth on the open market. Knowing your businesses’ value allows you to set a fair selling price and negotiate effectively with potential buyers and secure better financing deals, among other things. 

Perhaps you’re thinking of selling, merging, expanding, or are in need of additional capital to fuel your growth. Or, perhaps you need your number to help attract investors or raise your company’s profile in the media. A business valuation can provide all of this for you.

Ultimately, you need a clear understanding of where your business stands financially. Even if you have no immediate plans to sell or expand, a business valuation acts as a powerful metric because it sheds light on the strengths and weaknesses of your company, which can in turn help you to make better strategic decisions moving forward.

How do business valuations work?

Business valuations rely on several methods, each with strengths and weaknesses. They can also be combined to form a more complete picture of value. Here are the most common methods of valuation.

Asset-based valuation

Asset-based valuation is a method used to determine the worth of a company based on its tangible and intangible assets, for example: 

• Tangible assets: real estate, equipment, inventory, or machinery. 
• Intangible assets: patents, trademarks, copyrights, or your company brand.

In this valuation approach, the total value of the assets is calculated, and then any outstanding liabilities or debts are subtracted from it. 

The result is the net asset value, which represents the estimated value of the company. This method is especially useful for companies with valuable tangible assets, as mentioned above. 

However, asset-based valuation may not be suitable for companies whose primary value lies in intangible assets such as technology or branding, as it might not fully capture their potential future earnings and growth prospects.

Income-based valuation

Income-based valuation focuses on the company’s earnings and cash flow to determine its value. This method is particularly relevant for businesses that generate consistent cash flows, such as service-oriented companies or those in stable industries.

There are two main approaches to the income-based valuation method:

Capitalisation of earnings: This approach involves dividing the company’s expected annual earnings by a “capitalisation rate”. The capitalisation rate is derived from factors like: 

1. The company’s risk profile
2. Industry conditions, and 
3. Prevailing interest rates.

Discretionary earnings: discretionary earnings are a subset of the company’s profits, calculated by removing non-essential expenses from the total profit to get a clearer picture of the cash available for the owner to use as they see fit.

The result of either of these methods is the estimated income-based value of the company.

Discounted cash flow (DCF)

Discounted cash flow (DCF) valuation is a way to figure out how much a company might be worth in the future. It considers things like expected profits, cash flow, and other financial benefits the company might have coming its way.

By using this method, analysts can calculate the present value of all those future cash flows, taking into consideration the ‘time value’ of money. This method helps venture capitalists, angel investors, company owners, and analysts make smart decisions about how much a company is really worth, considering both its potential and the time it takes to get there.

To perform a DCF valuation, the following steps are typically taken:

Step 1: Cash flow forecast

First, analysts and/or investors will try to predict how much money your company will make in the coming years. They will look at things like how much money it made in the past, what’s happening in the market, and what the company’s management thinks will happen.

Step 2: Discount rate

Next, they consider that money today is usually worth more than the same amount of money in the future. So, they use something called the ‘discount rate,’ which takes into account how risky the company is and what they could earn if they invested their money elsewhere.

Step 3: Present value calculation

Now, they take all the future cash flows they estimated in Step 1 and bring them back to their ‘present value’, using the discount rate from Step 2. It’s like asking, ‘How much are all these future pounds worth in today’s pounds?’ 

They add up all these present values, and that gives us an idea of how much your company might be worth.

DCF is considered a comprehensive method as it accounts for both the company’s potential growth and the time value of money. It is widely used for valuing companies with uncertain cash flows or those in high-growth industries, such as technology startups.

Each valuation method has its advantages and limitations, and the choice of the appropriate method depends on the nature of the business, the industry, the availability of data, and the specific context of the valuation. 

Many times, a combination of these methods may be used to arrive at a more accurate estimate of a company’s worth.

What can affect your company’s valuation?

There are a couple of things that affect your company’s valuation, for better or for worse. Here are the factors and ways you can mitigate or reduce them, as well as improve on their valuation-increasing attributes.

Assets

🙁 Reducing factor: if your company has a lot of outdated or obsolete physical assets, it might negatively impact its valuation. 

😄 Boosting factor: You can take steps to either sell or upgrade these assets to increase their value or replace them with more efficient and modern equipment. You can also focus on enhancing the value of your intangible assets, such as patents, trademarks, brand reputation, and intellectual property. 

Securing intellectual property rights and investing in branding and marketing efforts can increase the perceived value of your company.

Earnings

🙁 Reducing factor: if your company is experiencing declining profits or inconsistent earnings, it might lower its overall valuation. 

😄 Boosting factor: increasing profitability through reassessing your pricing strategies, decreasing your cost of goods sold (COGS) score, chasing those invoices and employing efficient financial management can positively impact your company’s valuation. Demonstrating a track record of strong and sustainable earnings growth will be attractive to potential investors or buyers.

Growth prospects

🙁 Reducing factor: if your company lacks a clear growth strategy or is in an industry with limited expansion opportunities, it might hinder its valuation. 

😄 Boosting factor: Consider exploring new markets, products, or services to demonstrate growth potential. Articulate a well-defined growth plan, supported by market research and a sustainable competitive advantage, or maybe consider rebranding your business for a well-needed jump in excitement for customers. 

Risk

🙁 Reducing factor: there will always be the potential for risk in your business, such as economic downturns, regulatory changes, or reliance on a single target market. 

😄 Boosting factor: Do your best to identify and mitigate these potential risks as soon as possible, then implement risk management strategies to minimise their impact. 

Showcase a strong risk management framework that includes customer retention, customer loyalty, and a diversified business model. Investors and buyers will be more attracted to a company that has reduced exposure to external threats.

Market conditions

🙁 Reducing factor: During economic downturns (such as the cost of living crisis we’re currently facing and the pandemic, which meant so many prominent UK brands went into administration recently) – your overall business valuation across industries may be affected negatively here. 

😄 Boosting factor: While no one expects you to control external factors, you can focus on creating a business continuity plan and a “survival mode” protocol in order to weather the worst of any economic fluctuations. 

During good market conditions or in a growing economy, there may be increased demand for businesses in certain sectors. In such cases, you can leverage the market’s momentum to enhance your company’s valuation.

Market conditions can play a big role in how people see your company’s worth, and has more pull than business owners would like ideally in how our companies are viewed as is largely out of our control – but it is an inevitable part of the process.

You may have great products, happy customers, and a solid team. But guess what? The economy might decide to take a dive or soar to new heights, and that can affect how your company is valued. 

So, even if you’re doing everything right internally, external market conditions can still sway the numbers. But don’t let that discourage you! 

What you can do is focus on what you can control: your business’s performance, growth strategies, and operational efficiency. You can work on things within your company to make it stronger and more attractive. 

If you stay focused on your business strategy, financial performance, and industry trends, you can help your company thrive even when the market is a bit moody.

Stay positive, stay proactive, and keep building on your company’s main strengths. It’ll make a big difference in the long run.

When should you value a business?

We don’t recommend valuing your business at every small turn, because just like tarot card readers say: doing it too frequently can end up simply distracting, pie-in-the-sky speculating and unproductive overall. But there are several scenarios in which business valuation becomes essential. 

You should always value your business (even if you have previously) at specific and crucial moments in your business journey, including:

• Seeking to raise capital: when seeking investors or business loans, knowing your business’s value can attract better deals.
• Looking at merging, acquiring or selling: in order to set the right selling price and negotiate effectively with potential buyers. Before engaging in mergers or acquisitions, both parties need to understand the value of each business involved.
• Seeking investment or joint venture partnership: when considering bringing in investors or new partners, knowing the value of your business helps you negotiate terms confidently and attract the right partners who align with your vision.
• Resolving disputes or partnership changes: in cases of conflicts with partners or when someone wants to exit the business, a valuation provides an objective basis for resolving disagreements and ensuring better teamwork in the future.
• Preparing for retirement or exit: if you’re thinking about retiring or moving on to new ventures, valuing your business helps you understand its worth and plan for a smooth transition or sale. Knowing the value can give you peace of mind about your financial future.
• Succession planning: If you intend to pass your business to the next generation, or a family member, a valuation is essential. It ensures a fair distribution of assets, and can maintain family harmony if you’re keeping ownership close to home.
• Facing unexpected life events: life can be unpredictable, and unforeseen events such as health issues or personal emergencies may require you to reassess your business’s worth for financial planning.
• Assessing growth and achievements: valuing your business at key milestones can be a motivating way to celebrate your achievements and acknowledges the progress you’ve made. It may also give you a better shot and heightened confidence in applying for some of the UK’s most prestigious business awards.

What to do if your company valuation is lower than expected

If the valuation result disappoints you, don’t panic, there are always steps you can take.

1. Review your financial statements: double and triple-check for any errors or discrepancies in your financial records – one misplaced decimal can make quite a significant difference.
2. Adjust your assumptions: reevaluate your assumptions about future earnings and growth prospects to a place that is more realistic and in line with your projections. Perhaps things will take more time than you originally expected, or you will need to work harder at certain times in the month, for example, in order to hit your goals. It’s okay, don’t worry – just because your valuation doesn’t signify millions in your first month doesn’t mean you’re a failure!
3. Seek a second opinion: If you still feel uncertain, you can consult a business valuation expert for a fresh perspective. And, if you feel at a true impasse with prospective investors or buyers of your business, then this could be the moment to step back and seek alternatives.

Conclusion

In the end, business valuation emerges as a vital asset that every business owner should wholeheartedly adopt. 

Seeking this guidance about the different valuation methods, the factors affecting your company’s value, and the right time to seek valuation empowers you to make well-considered decisions that will steer your business towards a prosperous future.