Putting a price on a business can be challenging – whether you’re the buyer or the owner who’s looking to sell. Here, we reveal some essential tips and methods for assessing business value.

How to value a business

Thinking of buying a business – or selling your own? Pricing a business for sale can be tricky.

What you think a business is worth and what the other party thinks it’s worth are usually two different figures.

For a buyer, the worth of a business hinges on how much profit it will make, balanced by the risks involved. However, historic cash flow, profitability and asset values are only the starting points. It’s often the hard-to-measure factors such as key business relationships and goodwill that provide the most value.

What affects business viability?

There are three things to consider:

• circumstances of the sale
• tangible versus intangible assets
• years of operation.

Circumstances of the sale

The reasons for selling a business can affect its value. A forced sale is likely to drive down the value. For example, an owner in poor health may accept the first offer they receive, while an owner who goes through lengthy negotiations may get a higher price.

Tangible versus intangible assets

A business that owns property, machinery or stock-in-hand has tangible assets. These will have some resale value, making the business easier to value (including business asset valuation).

Many businesses have almost no tangible assets beyond office equipment. However, their intangible assets may have significant value, such as a well-respected brand, customer goodwill, intellectual property and potential for growth.

These intangibles can be harder to value, so ask your accountant for guidance if necessary.

Years of operation

The longer the business has been operating, the better the track record, cash flow and loyal customers who provide repeat business.

Be wary of businesses for sale that have only been trading between one and two years, such as bars or cafes. Such companies may be experiencing current popularity but the market may be about to turn away.

Business valuation methods

Remember, the true value of a business is always what someone is willing to pay for it. To arrive at a figure, buyers use various valuation methods. This is usually just to give a sense of reassurance that they’re not paying too much.

Here is a list of ways to value a business – profit based valuation, asset based valuation, rule of thumb, comparable sales method, capitalisation of future maintainable earnings, discounted cash flow etc.

As you can see there are a number of ways to value a business and we can discuss those with you when you need to find out more.

Other issues

The key source of business value may be something that can’t easily be measured. Putting a value on intangible assets isn’t easy because that value can vary depending on the nature of the assets and the industry.

See the following examples.

Strong relationships with key customers or suppliers

For example, if a business holds a licence or distributor rights across Australia for a product expected to be successful, the business’s value will increase accordingly.

Management stability

If the owner-manager or other key people are going to leave, the business may be worth far less. For example, the profitability of an advertising agency may collapse if a key creative person leaves.

Similarly, if key salespeople leave, they may take important customers with them. Any written agreements or incentives to retain key employees could add value, but they could also damage the business value if a potential buyer intends to bring in a new team.

Intellectual property ownership

If the business owns the rights to patents, copyrights or trademarks, these will add value to the purchase price of a business. For example, if you’re selling a patented invention, you can value your business higher than a similar business selling an unprotected product.

In some industry sectors, buying and selling businesses is common. This has led to industry-wide ‘rules of thumb’, which are dependent on factors other than profit.

Buyers will work out what the business is worth to them. Take the example of a computer maintenance business with 10,000 contracts but no profits. To one buyer, the business may be worth comparatively little. However, a larger competitor may pay $100 per contract to buy the business because it could merge the two businesses and make larger profits.

Contact us to find out more about valuing your business.