Whether you are buying or selling a business it’s imperative to know how much the business is worth to ensure you either make the correct value for the business or buy a business for what it’s truly worth. There are many trains on thought on the best method to value a business however this is method I have always used over the course of decades of running, selling and buying businesses and it’s never let me down.
The rule of thumb is this – the value of any business is ‘Net Profit multiplied by the Business Category Valuation Multiple’. That’s the core of any business valuation, there are of course numerous other factors which can come into play such as assets, brand awareness etc however this is the equation you need to start with before thinking about anything else when valuing a business.
Business Category Valuation Multiple
So if you’re reading this blog my hope is that you will already know what the business’ Net Profit is, or at least know how to work out what it is. If you’re unsure at this stage then my advice would be to read my previous blog on the different types of profit but the key fact is that net profit is your gross profit minus all your business overheads.
So once you know the gross profit you then need to find out which ‘Business Category Valuation Multiple’ the business falls under. It’s quite simple though so don’t worry, there’s just 2 to choose from:
- Service-related businesses multiple = 2 to 2.5
- Manufacturing-related business multiple = 3 to 3.5
What these refer to are simply the category which the business you’re wanting to value is listed under, so does the business offer a service (such as a marketing company who supply website and design services) or does the business mainly sell physical/digital products (manufacturing-related). That’s all you need to bear in mind when deciding whether the business is Service-related or Manufacturing-related.
Once you know the correct category you now know how much to multiply your net profit by – if it’s a service-related business you multiply the net profit by 2 to 2.5 or if it’s a manufacturing-related business then you multiply the net profit by 3 to 3.5.
Valuing a Business
So you now have the business’ net profit and the correct multiplier however there’s of course a little more to think about.
Let’s say the business you’re looking to value has a net profit of £50,o00 per year and it’s service related – in it’s most basic form this business should be valued at £50,000 multiplied by 2 which equals £100,000. But there is of course more to the story than just this!
The reason there is some leeway in regards to the multiplier being 2 to 2.5 or 3 to 3.5 is because there are other factors which you can add into the business valuation and it is here where you can start to add a decimal to your business valuation multiple.
For example, the business has a net profit of £50,000 but the ‘brand’ is extremely popular and is growing year-on-year to becoming a nationally recognised expert in its field. This is of course a reason to increase the value of the business since it wouldn’t just be selling the business on the basis of its income, this would be selling the business for its income and on the basis of the brand awareness and future potential.
This is just one of many examples for reasons to increase the value of a business and to be honest the list of factors which can be considered reasons for increasing a business valuation are rather endless however I’ve put a list of my top factors to consider when valuing any business:
- Assets being sold with the business
- Length of time the business has been running
- Brand awareness
- Email Marketing List
- Intellectual Property Ownership
Assets Being Sold with the Business
This is a key factor to bear in mind when valuing any business – when you buy or sell this business are there assets being sold with the business? For example are you about to sell a business which has a warehouse full of stock? Then you must be sure to get an official valuation of all the stock, the warehouse cost (if you own it) and any other assets such as forklift trucks, delivery vans etc.
The value of these assets must then be added on top of the ‘net profit multiplied by the business category multiple’ sum.
Length of Time the Business has been Running
Has the business been running for many years and has strong relationships with repeat customers as well as numerous ongoing contracts with clients? Then whoever buys this business is going to ‘hit the ground running’ and know there’s little risk with the purchase, therefore these are all factors to increase the business category multiple.
This ties in with my example above, but always think about the power of ‘the brand’ of a business. For example fo people recognise the logo? Is the brand trusted and reputable with hundreds of 5 star reviews? These are all strong factors to increase the value of any business since the purchaser gains this brand as well as the finances from this business.
Email Marketing List
In some industries a business’ email marketing list can be make or break, especially for online retailers etc. Therefore if the business has a large email marketing list then the new owner will have access to all of these contacts and therefore would expect to pay more for the privilege of having this database.
Please note when I say ‘large’ email marketing list I mean minimum of ‘5 digits’ in regards to the number of email addresses and contact information required on that list. Most businesses expect to have a few thousand customer emails but to really have a reason to increase the value of a business this needs to be a list containing at least 10,000 contact names and emails to be considered a true factor for consideration.
Intellectual Property Ownership
This can be a very big reason to increase the value of any business – is the new owner of the business going to also be gaining the rights to intellectual property? For example has the business designed a bespoke product and had the intellectual property patented so that no-one else can use this technology without their permission? Or is it simply a business who owns the intellectual property to a top-selling novel for example? Either way, this is a very strong reason to increase the value of the business since the new owner is going to gain added value form this intellectual property.
Exceptions to the Rule
So I’ve pretty much listed everything I wanted to include in this article about how to value a business, but there is of course always exceptions to the rule so I just wanted to use one example of this exception to ensure I’d covered the whole spectrum of business valuation.
There are times when businesses are valued for high amounts of money without having any net profit or assets to speak of and this is because an outsider can see the potential of a business and want to ensure no other competitor can get their hands on it. In these instances all rules go out the window and it’s simply up to the purchaser to put forward an offer they consider fair in regards to buying out the current owners and knowing how much they stand to make by purchasing this business.
There’s an endless list of examples here but the one that always sticks in my mind is this – Facebook bought Instagram for $1 billion when they hadn’t even made any money!
The reason is that Instagram has millions of users already registered and Facebook realised the potential of inegrating adverts into their platform. It’s that simple!
Now I’m not saying go out and try to sell or buy a business for insane amounts of money, the point I’m getting at here is to always be sure you know everything about yours or someone else’s business before purchasing and always bear in mind the potential of what could happen should the business fall into the right hands.
Final Tip for Valuing a Business
If you’re ever in doubt about the value of a business then my top tip is this, search online for similar businesses to the one you’re looking at and see how much it sold for. This will give you a good starting point from a real-life example, your business may be worth more or less depending on all factors listed above but at least you have something to reference.