When is a Business Valuation needed?

Business owners often believe that the only time a valuation is required is if the owner is thinking of selling or transferring their business. This is not always the case. We frequently engage with business owners as part of their strategic review to consider the value today, to then agree on the actions required to increase the desired future value. The strategic review can often recommend actions over several years, so the valuation needs to be done well in advance of the planned exit date.

Of course in some cases, the current valuation meets the expectations of the client, and they are happy to proceed with the exit.

How are businesses valued?

Most SME businesses are valued based on their recurring levels of profits. This means that one off expenses, for example, large pension or salary payments are normalised over a number of years, to estimate what level of profits the business will generate. By their nature, valuations use historic results to assess the future profit potential, which is itself a subjective measure.

Once the normalised profit is established, a multiple is typically applied to this, to arrive at the value of the business. The suitable multiple to apply will depend on several factors including the size of the business, the sector it is in, the strength of the customer base and management team etc. Multiples typically range from 3 to 5 times profits but can vary widely and must be considered on a case by case basis.

This methodology will not include the value of a freehold property, if this is owned by the business. The property valuation is a separate exercise and is not examined here.

This multiple of earnings approach may not be suitable for all businesses. For example, certain businesses may require a large investment in plant and machinery, and the market value of those assets could far exceed an earnings based valuation.