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How to value a business

As an avid viewer of Dragons Den it is clear that the value of a business can be very different depending upon whose view is being taken.  Someone looking to invest or purchase a business is likely to put a lower value on it than the person selling.  This is shown time and time again, when an angered dragon is unimpressed by the directors over ambitious expectation and valuation.

So how can a business be valued and is there one value for a business?

In an insolvent and distressed situation the answer is usually quite simple.  The business is worth what someone is prepared to pay for it.  Whilst there may be formulas to work out the true value, if no one will pay that then this becomes irrelevant.  In the cases of small businesses it is often that a significant amount value may be with the directors themselves.  The relationships that they are able to build up and the customers they have are often not set out in contracts, therefore the value to a third party would be significantly less, especially if the director is not going to move with the business.  With the business ceasing to trade the goodwill can be affected significantly.

The value of a trading company will often come down to a range of figures and will be calculated using past performance as an indication of future performance together as well as future projections.  The value of the business will depend upon for example whether there are contracts in place, where the business falls within the sector and whether it has a unique selling point.  To ensure maximum value directors should be looking at the strengths and opportunities of the company and maximising these, whilst minimising the weaknesses and threats.  By differentiating from the competition and looking for diversifying opportunities a director may be able to increase the value.

If there is a sale, then often the purchasers valuation will be lower than the sellers.  The purchasers will often view the weaknesses as being more important and they may be more objective when looking at the business.  The seller will often value the intangible elements of the business higher, taking into account long term customers and a loyal workforce.  For the purchaser they may not put much value on this if there are not contracts in place to guarantee future custom.

Employees are an interesting area as well.  The same employees could be viewed as a strength by some and a weakness by others.  Take for example a company with a loyal workforce, with those working for the company being employed for 10 or even 20 years.  For the director he is able to rely on this workforce, knowing that they have the expertise to carry out the day to day work, a major strength.   A purchaser though may be seeking to rationalise the workforce, particularly for example if they are more focused on technology and automation.  For the purchaser, the costs of redundancy may have a major impact upon their decision and upon the valuation.  For the purchaser these same employees may be a weakness.

As the price is likely to differ depending upon who is valuing it and for what reason, for many the valuation is only the first step.  After that comes the negotiation, with the actual price usually ending up somewhere between the two.  It is important for the buyer to go into this knowing the maximum they will pay, for the purchaser, they will need to know the minimum they would accept and therefore the initial valuation is important to get these benchmarks in place.  Hopefully the final position is one that satisfies both.

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