Business valuation is far from being an exact science. There are so many factors that come into valuing a business that there is no formula one can use to get “The” valuation of a business. A wishy-washy answer would be that the valuation of a company is down to what someone will pay for it – that is true, but ultimately that person must use some principles to come up with what they think is a reasonable price.
Drawing on my extensive research on the subject (including the doorstop of a textbook I have on my bookshelf!), my experience of working with business owners as an accountant and business investor, and the experiences of my fellow business investors in my network, let’s have a look at some principles we could apply to come up with a valuation on a business.
I have created the Reida Base Model to cover the 5 internal aspects of a business to be able to build up a business valuation. We’ll look at each area in turn and then see what it looks like in a good old widget manufacturing company called Widget Co Ltd.
R – Revenue Generating Net Assets
Revenue Generating Assets are instrumental in making the business operate – it will include the fixed assets as well as current assets.
In Widget Co Ltd this would include the widget making machines and a fleet of delivery vehicles, while the current assets and liaibilties relating to the lifecycle of the product manufacture and distribution would include cash, debtors (the company’s receivables), creditors (the compay’s payables) and inventories/stock.
E – Excess Assets
Excess assets would include any assets that the company is holding that is over and above the requirement for generating revenue.
In Widget Co Ltd, we might see excess cash that has not been withdrawn from the company and the company might own the property it operates from – the property wouldn’t be necessary to be able to generate revenue, as it could do that just as well from a rented property – so the value of the property would be taken into account in a valuation as an excess asset.
I – Intangible Assets
Intangible is something that does not have a physical presence, so too are intangible assets and could include things like:
- Brand identity
- Repeating customer base
- Internally generated routes to market (for example a fully functional e-commerce website would be an internally generated route to market vs selling on Amazon, which would not count as being an asset of the company)
- Fully documented systems and procedures
- Registered Intellectual Property
- Social media handles, domain names etc
Of course, attributing a value to these items will be a very subjective process, there is no ‘market’ for such things as they are usually integrated into a business.
D – Debt
Generally in the form of loans, consideration should be given to the type of loan, for example – is it a shareholder loan? Is it a bank loan with a personal guarantee? Is it a BBL or CBILS? How much of that loan is still retained within the business as cash or has it all been spent? Is it a mortgage against the property held in the business, how many parties have
A – Annual Returns
This is the total turnover made as a result of the invested assets and liabilities held by the business, less the monthly and annual expenses to achieve the turnover.
So, how could the Reida Base be used in creating a number to start negotiations?
Where the business is a revenue focused business, I would start with a multiple of Annual Returns and then add and subtract from that figure with excess assets, intangible assets and debt, depending on what is relevant for the business you are dealing with.
Where the business is more balance sheet focused, i.e. on the assets or net assets of the business; the revenue generating, excess and intangible assets along with the debt figures would come together to bring you a number for negotiation.