Exit planning is a crucial facet of any long-term business development strategy, and becomes especially pressing once business owners start reaching a ‘certain age’. As a business owner, exit planning should be considered at the same time as your retirement plans. Assuming for now that you will eventually want to sell your business, rather than transfer ownership to a family member, exit planning involves creating a roadmap to maximise the value of the business before its sale, transfer, or merger with another company.
In this article, we’ll look at the nuts and bolts of how British companies are valued, and the various methods used to determine the worth of a business.
Market Value Versus Intrinsic Value
The two main metrics used to value a company are market value and intrinsic value. The market value of a business is the current price for which it could be bought or sold on the current market, and is strongly affected by desirability and competition. Intrinsic value, on the other hand, represents the true value of an asset or business, considering the company’s management, physical and intellectual assets, property, and future potential.
Market value can fluctuate over time depending on perceived demand, supply chain factors, and external conditions, which is why intrinsic value is a more accurate long-term representation of your business’s worth. However, market value is often used for valuation purposes, especially when working with an agent, as it gives a good indication of what the business could be sold for if it went to market today.
Methods Used To Evaluate UK Limited Companies
There are several methods that prospective buyers and investors use to determine the value of a British company, the main ones being:
1. Market Comparable Approach:
This strategy involves comparing your business to similar companies in the same sector that have recently been sold or valued. These valuations are used as a benchmark to determine the worth of your business. It’s similar to how estate agents value new properties coming onto the market.
2. Discounted Cash Flow (DCF):
The DCF method calculates your business’s value by forecasting its future cash flow and then discounting it to your present value. Estimates are made using the projected growth rate of your company and the wider economy, as well as the time value of money (TVM – a financial concept that recognises that money available today is worth more than the same amount in the future due to its potential earning capacity).
3. Asset-Based Valuation:
Asset-based valuation determines a business’s worth based on its tangible assets – e.g. plant, property, stock, and equipment, and intangible assets, which include bespoke software, patents, trademarks, and other intellectual property. The value is calculated by subtracting liabilities (e.g. debts, payroll) from your total asset value.
4. Earnings Multiple Method:
This strategy uses a multiple of earnings, such as price to earnings ratio, to determine your company’s value. The method is often used for valuing publicly traded/plc businesses, but not so frequently for private limited companies.
What Factors Affect Your Valuation?
Unfortunately, valuation is not an exact science, and there is less standardisation in the world of business sales than there is for the property market. In practice, the value of a business rests on several factors, such as:
1. Your Sector:
investors in different industries often use different valuation benchmarks and metrics. For instance, tech companies and start-ups are often valued on their potential for growth, while manufacturing and logistics businesses may be valued on their assets.
2. Financial Performance:
the financial performance of your business, including its revenues, historic profits, and cash flow, can greatly influences valuation. Many investors value consistency and sustained growth over sketchy growth or spikes in demand.
3. Economic Conditions:
external economic conditions, including interest rates, geopolitical and social factors, technology, and the general economic climate can also strongly impact the market value of your business and the amount you can expect from the sale.
The Importance Of An Accurate Company Valuation
To obtain the maximum value for your business before its eventual sale, an accurate business valuation is essential. If your business is undervalued, you essentially leave potential profits on the table, while an overvalued company may struggle to find a buyer or secure financing for transfer (e.g. in a management buy-out). For the best value, a business should ideally perform well using all four valuation methods. Although individual companies normally excel in one or more areas compared to others, it’s worth investing long-term in your comparative market share, cash flow resilience, asset base, and earnings, in order to broaden your appeal to potential investors.
Next Steps
JDR work with business owners to maximise the value of their companies as part of an exit strategy. Whether you are actively planning your retirement or your exit is decades in the future, it’s worth considering today how to develop and grow your business over time. Get in touch with one of our experienced business development team today for more information.
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