Your business’s value dictates many things. It determines how much you can expect to receive upon the sale of the company, and it’s a critical factor in your eligibility for finance – including investment and commercial loans.
The higher your value, the more your company is worth to shareholders, buyers and other stakeholders.
Although it’s common to hear people speak about ‘value’, not everyone knows how it’s calculated.
We have listed the factors that drive your overall company value to make it easier to understand any valuation you receive.
The different approaches to valuation
There are four primary approaches used to evaluate a business’s value. Each has a different focus, so your business’ estimated worth can vary depending on which is used.
The first is the book value approach, which focuses on your assets and liabilities. The value of your assets minus any liabilities will be used to uncover the value. If a company has £5 million in assets, but £3 million in liabilities, it would be worth £2 million.
Next is the income-based approach, which is based loosely on the stock market. It considers what similar companies’ price earnings ratio are. You then take the price earnings ratio of a similar company and multiply it by the EBITDA (earnings before interest, tax, depreciation, and amortisation) to work out the company value.
Then there’s the discounted cashflow model calculates the present value of future cash flows based on the discount rate and time period of the analysis. It is often used as a way of valuing companies that are yet to make a profit.
The final approach focuses on income. It divides annual earnings by the capitalisation rate (used to convert a company’s yearly earnings into its overall value). If your capitalisation rate were one-third and your revenue was £100,000, your value would be £300,000.
Alongside the different approaches, remember that your valuation will shift depending on the context. Valuators will prioritise specific aspects that may make perceived worth fluctuate. Don’t be surprised if you get different estimates – though they shouldn’t change dramatically.
Factors that make up your company value
One of the first things to consider when working out a company’s value is the assets it owns. As outlined in the asset approach, these are added together to work out your value.
Examples of assets that will be included:
- Equipment, including plant, machinery, office furniture, it equipment, etc
- Owned premises
- Company vehicles
- Stock and inventory
- Cash & debtors
In the case of a sale, a buyer will typically want to take on your assets, while a lender will see them as collateral, they can use to secure any funding.
Debt and liabilities
Debt and other liabilities will lower a company’s value. Examples include bank loan and overdrafts, hire purchase contracts, trade creditors, wages, taxes, leases, and other creditors.
Every business has liabilities, but you want to minimise them to drive up your worth – such as by paying off debt promptly or managing your regular costs effectively.
Revenue is the value of sales made by a company, typically from selling your products and services. You may have other sources of income too.
Higher revenue will boost your value. It also generally showcases good customer demand and performance, which will make you more attractive to financers or buyers.
Cash flow is the net impact between the incoming and outgoing payments. A positive cash flow usually means you can more readily meet financial commitments and survive temporary cash issues.
Like revenue, cash flow is an indicator of performance. Positive cash flow will make you more appealing to anyone looking to fund or buy your business. Although it isn’t directly calculated as part of your value, it will improve your perceived worth.
In the same vein as revenue and cash flow, your financial history will determine your perceived wealth.
A business that has a solid and consistent financial record is more appealing. One with a history of debt or other issues may struggle to be considered valuable.
A poor financial history doesn’t necessarily mean poor value, especially if you have since resolved the issue and now have good growth potential. However, it could present a barrier to overcome.
Your overall performance has a huge bearing on your company value. Performance is attributed to many qualities, including financial performance (revenue and profit) or other aspects (e.g. customer satisfaction rates and brand reputation).
Although these aspects aren’t used in any valuation model, they will improve your appeal.
The better your financial performance, the more highly valued will be your business. The added value of other aspects may vary depending on the context – for example, if a buyer prioritises a positive brand reputation, they could be willing to pay an additional premium.
Your business has people behind it, including your leadership team and other employees, who all impact value.
If you have a strong management team and skilled workers (primarily if you operate in an industry where such skill is hard to come by), it’s likely to drive the worth of your company.
Financiers will also consider your staff when deciding whether to fund you, so a strong workforce will work in your favour and improve eligibility.
Intellectual property (IP) refers to your business’s innovative processes, inventions, and ideas. It is protected by law to prevent others from stealing it. Examples include patents, designs, and trademarks.
IP also has ramifications for your value. It is often treated as an asset, so your value could rocket for buyers and funders alike if it is highly sought-after.
You don’t have to sell it in a business sale, but IP is likely to be considered integral to any sale and increase the business value.
Specific sectors tend to raise more due to varying levels of demand. If your company is in a booming industry, it’s more likely to be seen as valuable as you have better chances of financial success.
Your position in your market also matters. Market leaders tend to be more valuable as they take the lion’s share of sales. If you’re a market disruptor, you will also be highly valued, especially by competitors who want to acquire your business and remove the threat to their revenue.
Contracts and client books
The quality of your customers and their contracts can be critical when applying for funding, your customers can also determine the sale value.
When buyers are looking at your business, they will want to ensure they’re getting their money’s worth and obtaining a financially viable venture. If you have significant customers on your books or long-term contracts, it suggests stable income and profit, which will attract buyers and funders alike.
It will also attract competitors who want to seize your customers, which can increase your business’s value ahead of a potential merger or acquisition.
Your competitors won’t have any direct impact on value. However, similar companies’ value is often used as a benchmark to determine your value.
Many factors will affect competitor value, including demand in the industry and the assets they have. To understand your importance better, look at what value similar-sized businesses have obtained before getting your valuation.
Growth potential is a significant factor of value.
For funders, a business with high growth potential signals a return on investment or an increased ability to repay loans. For buyers, it shows a business with potential and future business value post acquisition.
This leads to a significantly higher business value.
It’s one thing to receive a figure telling you the value of your business, but it’s another to understand what influences it. By knowing the factors that go into your valuation, you should be able to establish if it is justified.
Understanding what comprises your value will also make it easier to maximise it. In turn, this improves your eligibility for funding and grows the price you can expect to fetch upon exit.
We take you through a process to improve your business’s value ahead of a sale or funding application. Get in touch today to find out more.
Get in touch.