Establishing the value of a business is a common request of business advisers. And it requires a high level of skill and experience to answer accurately.
You can value a house based on its condition, its location, the number of rooms and the amount comparable properties have sold for. You can value a painting on the reputation of the artist, the quality of the painting and auction prices for similar works.
But these are tangible values. And while most businesses have things that can be discreetly measured, there are many intangibles too, from copyright and intellectual property to brands and patents, and many other business assets that can add to a company’s value.
There is no simple formula to determine the value of your business. It’s a very difficult calculation for any valuer to make unless market conditions are perfect, i.e., where there is a true market base with buyers and sellers regularly entering into similar transactions.
However, markets are volatile. So getting an accurate valuation of your business relies on choosing a skilled valuer – someone with the ability to combine knowledge and experience with application of valuation principles to come up with an opinion on the value of the business.
To give you an idea of what is involved, some of the key accepted principles a valuer will use include:
A hypothetical market place:
Here, the valuer considers the valuation in terms of a willing but not anxious seller, and a willing but not anxious buyer, with both possessing similar facts and in friendly negotiation.
A business’s value is determined by the income stream it will generate, either from the profits/cashflow of the business or from the ultimate realisation of the assets of the business.
Determining the future maintainable profits (FMP) of the business is therefore a critical component of the valuation process.
To determine the FMP the valuer must not only look at historic events, but look at trends to provide a guide to the future.
Once the FMP is determined the valuer must determine an appropriate multiple to apply to it. The multiple represents the risk profile of the business.
The lower the multiple, the higher the risk profile of the business. As an example, there may be two businesses that each generate a profit of $200,000 per annum.
Business A could have a diverse customer base, a strong management team and good reputation in the market place, while Business B could be heavily reliant on one customer and only have traded for a year.
A prudent purchaser would be prepared to pay a greater price for Business A than for Business B.
The multiple applied to the FMP of Business A would therefore be greater than Business B.
Underlying business assets:
Having considered the FMP and appropriate multiple for the business, the valuer must then consider the result in light of the underlying assets of the business.
If a figure results in a value significantly less than the underlying net tangible assets of the business, the valuer should then consider the merits of a notional liquidation valuation.
Whereas if a figure results in a value significantly higher than the underlying net tangible assets, the valuer should consider the level and appropriateness of the resulting goodwill element.
Despite taking into account these principles, the valuation of any business is actually more of an art than a science.
It requires the ability to take into account all surrounding business facts along with knowledge of the sector, precedents and risks, while making judgment calls along the way.
So if you’re after an accurate assessment of the value of your business, make sure the valuer is experienced.
Read more about BDO's valuation services.