There are many good reasons to look at valuing your business, whether it is to sell it, seek equity investment or apply for business finance. Just make sure you do your homework, prepare all your documents and understand exactly what is at stake.
Reasons To Value Your Business
For many business owners valuing a business isn’t necessary until it comes time to seeking external investment. Most family-owned businesses, established over one or countless generations, might well have fixed and stable revenue streams. But, over time customer buying habits change and technologies advance, meaning revenue decreases and profits turn to losses.
When a business is looking for investment, whether to re-market itself, develop new product lines or establish a strong presence in a niche industry, it is often done through external investment. And one of the fastest growing types of business finance is equity investment.
At this point it would be wise to understand the relative and actual value of your business, what is it worth and what it could be worth if it received capital investment. Because there are many good reasons to do so .
Applying for business finance
If you are seeking a bank loan or other type of business finance product then the financial provider will undoubtedly be looking to identify the value of your business to establish whether their business finance is a prudent offering.
You are considering a takeover
If a rival business is looking to buy you out (assuming of course that you are open to this type of offer) then you will want to establish the very best price for your company. No business is going to offer you more than it is legitimately worth, yet they will be looking to seek a purchase price as low as they can. therefore it is common sense to establish your own business valuation as a benchmark.
You are considering retirement
For many business owners, retirement doesn’t necessarily mean selling up their company and living on a barge in rural Staffordshire. But how much their business is actually worth can make a huge difference in the quality of their post-working years. Having a company valuation completed long before that retirement date can help a business ensure it is still trading when your pension age finally catches up with you.
You are offering a stake in your business to key management employees
While you may not want to sell your business or give up a majority shareholding in it, you may feel it necessary to offer up a percentage of the business to key management staff who require that incentive to drive the business forward. In this case, a valuation of the business is essential to offering fair value to those who may wish to succeed you in the future or who will seek to increase the value of the business.
What Information Do You Need When Valuing Your Business?
Before you even consider putting a value on your business you’ll need to prepare your information. This means gathering the necessary documents together that will provide all the facts, figures and details that will be used for your business valuation.
Company History – A statement detailing the origins of the company, including how and why it was formed, where it is located and its core operations. Your company history should include any significant moments, breakthroughs, achievements and other compelling stories that have shaped it – whether this is through perseverance, courage or just luck.
Market Analysis – Detailed demographic information of the company’s market share. This will be a competitive analysis detailing market share which includes what the company’s services and products are. You should include a complete list of suppliers, customers and competitors.
Company Ownership – What is the ownership structure of the business? Include its legal structure being clear on who owns what and how much they own, as well as share distribution. Be sure to add any details relating to percentages and outstanding investments from directors/shareholders etc.
Personnel Data – Include a company organisation chart which should state the business CVs of the company owners and key management staff. Highlight payroll figures of all employees including a list of employee positions and a brief job description.
Profit & Loss Statements – Provide quarterly balance sheets for as long as the company has been in existence (or at least the last 3 years) which show reported expenditure and revenue for each period.
Financial Forecasts – Present any financial forecasts alongside your profit & loss statements and balance sheets.
Company Accounts – Make sure you have all your previous tax returns from your accountant showing what the company paid in tax and its reported profits for each year (or at least the last 3 years). if you are a sole trader then this will be your personal tax records.
Accounts Received – Payment history of all customers, including an aged-debtor report accounting for the past three years.
Pensions and Benefits – Information and costings for all employee benefits schemes, including pension provisions and payments and retirement plans, profit-sharing and stock options
Contracts & Intellectual Property – Copies of all contractual agreements including for all customers, directors and shareholders. A list of any patents owned, licensing agreements, trademarks, brands and intellectual property, including digital and physical.
What Is/Isn’t Included? – If you are selling the company be clear on what is and is not up for sale; there isn’t any room for ambiguity in a company valuation, so be clear on what assets/stock/income streams are included.
How Investors Value Your Business
Even if you aren’t selling your business, but trying to attract business finance, usually in the form of angel investment or equity finance, then it’s worth understanding how an investor views your business and what information they consider essential when putting a value on it.
Firstly, before entering into negotiations, there are two key terms you’ll need to understand because any potential investor certainly will.
- Pre-Money Valuation
- Post-Money Valuation
Pre-Money Valuation
This is the equation that investor use to work out the percentage of the business they will hold ownership of. So if your business, before the investment is worth £1,000,000 and the investor is looking to invest £250,000 of their money into it, then the equation would look like:
Investor Equity = Investment Amount / (Pre-Money Valuation + Investment Amount)
Equity percentage of investor 20% = £250,000 / £1,250,000
Post-Money Valuation
This is the new value of the company after investment of capital finance has been added to its balance sheet, i.e., in this case, £1,250,000.
The reason this is important is that the ownership value of your company can greatly differ whether you are applying pre-money valuation or post-money valuation figures to it. The pre-money valuation gives the investor a clear 20% ownership, but that figure moves to 25% if a post-money valuation is applied.
Depending on the nature of your business, the industry it is in, the expected returns, and the degree of potential profitability of your forecasts, this figure might change. However, it is an important rule of thumb to consider when entering into value negotiations with potential investors and the realistic share of your company you will be parting ownership with.
Investor Methodology: Valuing Your Business
Most investors will not only go through your finances, order book, company information and personnel files with a fine tooth comb, but they will also look at a bigger picture of where your business fits into known industry expectations.
Investors look at two valuation methodologies for the basis of valuing your business and measuring their investment. They will find recent comparable financing and also look at potential exit value.
- Recent comparable finance – Most investors are pretty wise to what kind of finance deals are happening and what investment opportunities are currently available. They will use this information to establish a valuation range for your company.
- Potential exit value – Recent business sales and valuations will give a good indication of a company’s exit value because this is the point at which big money can be made for investors and founders.
These two methodologies work alongside all other known factors as well as taking into consideration the individual circumstances of the business being valued.
Very simply for investors to determine what their investment should be will be based on calculating what the likely exit size will have to be for a company (like yours) in order for them to reach their return on investment goal. From this, they can work out how much investment is needed to get to that stage.
How To Maximise The Value of Your Business
Make a compelling exit case – Demonstrate to investors how and why there is a big exit value for your company make sure your comparable financial figures relate to the known value of similar businesses in your sector and be clear on the timescales expected.
Due diligence – Do your homework and understand the valuations of companies at a similar and later stage. Ensure your business plan covers the gaps in your technology and commercial know-how between them.
Identify investment competitors – Don’t put all your eggs in one basket, ensure that you generate competition for your business. If you can successfully get the attention of one investor, then you it should be possible to find another. Competition raises the value of your company.
So, yes, there are many different ‘scientific’ techniques you and investors can employ to determine the value of your business, it will nevertheless be defined by what someone is actually prepared to pay for it.
If you are looking for business finance and have considered either equity investment or other external investment options, talk to Funding Guru to see how we can help your business generate capital funding and business finance to maximise the value of your company.
