How to value your business and the key factors that can impact its worth

DEVELOPMENT BANK OF WALES SHARES ITS EXPERTISE AROUND BUSINESS VALUATION

DO you know how much your business is worth?

If you’re thinking of selling or buying a business, or raising equity investment, then this is a question you’ll need to answer.

However, it’s often said that valuation is more of an art than a science, so it can be tricky to determine.

There are a number of factors that can affect it, such as market sentiment, consistency of profits, customer/supplier concentration, level of assets/debt or surplus cash, and the management team, to name but a few.

Here, experts from the Development Bank of Wales share their advice around this subject and the support available to businesses.

HOW DO YOU VALUE AN ESTABLISHED COMPANY?

Bethan Cousins, new business director at the Development Bank of Wales, explained: “The most commonly used valuations for established businesses involve a multiple being applied to a company metric. This is usually the company’s profits, or sometimes its sales, or an industry-specific measure such as room occupancy for a hotel.”

“Working out the correct multiple to use is then the next trick. The usual way of doing this is to look at prices paid for similar businesses in the past or to look at the valuations of similar businesses quoted on the stock market.”

“These can vary widely by sector and company size. Picking the right companies for comparison is very important. Remember, multiples for listed businesses will vary significantly to those for private companies because there is no open market for the shares.”

“Generally, the multiples are applied to actual historic results for, say, the last 2-3 financial years.

Occasionally, they may be applied to current ‘run rate’ or forecast figures, particularly if the figures are supported by secured contracts. So, if you are thinking of selling your business, both good historic information (audited accounts or comprehensive management accounts) and reliable forecasts are important.”

“Typically, this number will then be adjusted for any excess assets (such as any assets over and above what is used to generate profits, like surplus cash) and debt (such as bank funding).”

“The important thing to remember, though, is that ultimately there is no such thing as a correct value for a business, only a range of values that are acceptable to both the buyer/investor and the seller. An advisor can help in determining a range of valuations and support in your negotiations.”

HOW DO YOU VALUE A TECH START-UP?

Alexander Leigh, senior investment executive in the technology venture investments (TVI) team at the Development Bank of Wales, added: “Valuation is challenging for any small-to-medium-sized business, but it’s especially tricky for start-ups with little or no historical data to be benchmarked against.”

“For pre-revenue companies, a common valuation technique is the Berkus method. This is where you assign a financial value to five fundamental aspects of the company (including the soundness of the idea and the capabilities of the management team) and then sum them. Another approach is the risk factor summation method, which involves assessing various types of risk associated with start-ups.”

“When it comes to valuing post-revenue companies, discounted cash flow, valuation multiples, and the venture capital method are among the most popular techniques. Discounted cash flow is a way of calculating what a business is worth by using projected cash flows and discounting them back to the present day, while the valuation multiples approach involves comparing a fundamental metric of a start-up, like revenue, to other similar companies. The aim of the venture capital method is to determine the exit price and then reverse engineer the calculations until you reach a pre-money valuation.”

“Whichever method you choose, don’t forget the main purpose of the whole exercise: to get cash into your business so you can grow it, while ensuring a fair exchange of value in the process. Ultimately, the valuation that matters is the one you achieve at exit, and you need to work hand in hand with your investors to get there.” As Paul Graham writes in his essay, How to Raise Money, “The number one thing you want from fundraising is to get the money you need, so you can get back to focusing on the real test, the success of your company. Number two is good investors. Valuation is at best third.”

“While it’s important to ensure you don’t get diluted too much on each round, you can take some comfort from the fact that incoming investors will always protect management. Good investors understand that it is all about the team. So, if you have built a solid business, your incoming investors will likely re-up your equity stake if they don’t feel you’re sufficiently incentivised.”

To learn more about valuation and other aspects of equity fundraising, sign up to Expanding Horizons with Equity LIVE.

This half-day conference on November 4, 2021 will bring leading finance figures and business owners together to share their experiences of equity investment.

Visit www.equity.wales to find out more and register your place.