Valuing a business: the three foundations of any valuation

(and how a little attention to them can significantly boost the value of your business)

As programs such as the BBC’s Dragon’s Den amply demonstrate, valuing any non-publicly traded business can be as much about ‘gut feel’ as mathematical equations.
That said, when putting a finger in the air, Duncan Bannatyne and bank managers alike will consider the same three foundations of value. Here, we look at what they are and what owners can do to improve how they are perceived.

Business buyers are interested in buying assets, things that are worth something. All formal methods of business valuation are, in effect, ways of classifying different assets, and they boil down to just three:

1. Book asset value: the bankable cash value of the assets of a business. Most of these will be physical items such as office equipment and property. They can include intellectual property, such as the rights to a respected name, especially where that property has a demonstrable market value, but it does not include the goodwill which is often the main value of a healthy going concern.

2. Earnings: A business which is a healthy going concern will be producing profits every year. Buyers will look at the likelihood of that profitability continuing were they to buy the company and how long it to would take for them to get their money back. Note that the earnings that count are those remaining after all executives needed to run the business, have been paid.

3. Intangible assets: goodwill, human capital, access to customers and markets and more. This is where the interests of the bank managers and the Duncan Bannatyne’s of the business world tend to part company.

Book asset value, for most businesses, ‘is what it is’ and there is not much you can do about it. Consequently, this tends to be the easiest area in which tot up the sums involved. Some values, however, can be improved without corresponding costs.

Improving book values at low cost
The idea here is to crystallize, as far as possible, the value of existing assets, so they are seen less as Intangibles & Goodwill (typically subject to far greater risk and thus discounting), and more as sellable assets. For example:

A little administration can work wonders here. Many companies which have been trading for any length of time have real value in their name and product names – value which can be at least partly crystallized by registering the relevant names and trademarks.

Contracts to supply
In some sectors, contracts to supply are relatively easily transferrable and thus, if the contract is firm enough, sellable. Formalising your agreements can transform such commitments into highly credible assets.

Leased premises
The value of a lease on premises can be a zero, even a serious liability (if your rent is higher than market rates or you have costly obligations to repair) or, in prime areas, an asset capable of commanding significant ‘key money’. Businesses fortunate enough to be in such prime areas can, through the simple process of a formal valuation, include this key money within their Book Assets, thus boosting their baseline value.

Earnings, even more than book assets, are easy to quantify – just look at the company accounts. The longer and more consistent the record of earnings, the more reliable they look and thus the less a buyer will discount the likely value of future earnings. In high-profile share sales, we often hear stories of sales at extraordinary multiples of ten or even twenty times earnings. Be warned – such instances are so rare they are best disregarded. In practice, few businesses that sell at all, sell for between one and five times average earnings.

Improving earnings multiples at low cost
The key here is reliability. Anything you can do to make it more likely that the earnings of your business will continue to be healthy, will improve a buyer’s perception of the quality of the ‘earning machine’ he or she is thinking of buying. Amazon, for example, now offers grocery customers an extra discount if they “subscribe” to any item – i.e. commit to repeat orders every month or two. Similarly, regular clients of a business will often agree to retainer contracts which reflect their typical annual spend, adding, in the process, far more value to the business than any discount given.

Intangible assets usually represent the big grey area. What are your relationships worth? Are they worth anything when you leave? What is the value of the affection customers feel for your products/it’s owner? This is where the old adage ‘It’s what someone will pay’ applies most of all.

Improving the value of Intangibles at low cost
Once again, this is all about seeking certainty and reliability. For example if, as so many companies say, their greatest asset is their staff, those employees will be worth a lot more with good contracts, a demonstrably low employee turnover and other hard evidence that the key people want to remain in post. Alternatively, if market share within a geographical territory is central to value, staff contracts with legally enforceable restrictions of trade might be more important, as could be evidence that departing staff couldn’t walk out with vital intellectual property.

If customer loyalty is central to the goodwill value, good evidence of that will reassure buyers. For services, this might involve simple things such as the willingness of clients to provide endorsements or referrals. For physical products, it could be a big fan base on a social media site. Veuve Cliquot champagne, for example, currently has over 175,000 ‘likes’ on its Facebook page. These are people it can contact directly and have a dialogue with. Perhaps more impressively, Joe’s Speciality Sausages in Southport, Merseyside, has 17,656!

For more information on how to value and sell a business, please contact your local office of The Business Partnership – the business broker solicitors and accountants recommend.