There is a variety of circumstances in which a business owner might want to value their business, a part of the business, or another business.
We are often called upon to assist with this.
Common examples include:
- Shareholders want to prepare for a trade sale, MBO or employee ownership deal and require an opinion on fair value.
- Employee share awards, where it may be necessary to negotiate valuations with HMRC, either pre- or post-transaction.
- A business acquisition is proposed, and an opinion is required on the fair value of the target.
- A retiring shareholder requires an opinion on the value of shares that are to be bought back by the company or sold to remaining shareholders.
- Inheritance Tax or Capital Gains Tax matters, when it may be necessary to value shares or business assets to quantify and report tax exposures.
There is a range of valuation approaches that may be deployed, and the selection of an appropriate method depends very much on the specific circumstances.
However, broadly speaking, there are three categories of valuation
- The income-based approach
- The market-based approach
- The asset-based approach.
We'll take a brief look at each method in turn, but you should always discuss your options with a qualified accountant before proceeding.
Income-based approach
An income-based approach seeks to value a business based on the expected future cash flows, discounted back to a present-day value.
This technique can work well where future cash flows can be estimated reasonably reliably.
It may, for example, be a suitable method for valuing minority shareholdings in a company that demonstrates a history of steady and predictable dividends.
Market-based approach
A market-based approach seeks to value a business by comparing it to other companies in the same industry that have recently been sold.
Metrics such as Enterprise Value to “earnings before interest, taxes, depreciation, and amortisation” (EBITDA) or Revenue Multiples may be derived from recent deals and then applied to the target company.
The method can work particularly well for valuing controlling shareholdings, but if there is no active market for similar businesses (as may sometimes be the case, particularly for smaller SMEs) then it can be difficult to identify suitable metrics.
Asset-based approach
An asset-based approach calculates the value of a business by reference to the market value of the assets, less the liabilities.
If the market value of the assets cannot readily be determined than the estimated cost of replacing those assets may instead be used.
The technique may be suitable for valuing businesses with significant tangible assets, such as property investment or manufacturing companies and those business that are in a liquidation or distressed sale situation.
It may not be suitable in situations where the true value of the company's assets, including things like goodwill or intellectual property, might not be captured.
Which is best for you?
Your choice of valuation method (or indeed combination of methods) will depend on careful consideration of the nature of your business, the purpose of the valuation, and the availability and reliability of data.
Often, I suggest using more than one method and then comparing the results, before arriving at a final opinion on valuation.
This can help provide a more balanced view and enables the question to be approached from several angles – avoiding missing out on key information.
