Business Valuation 1: 5 Ways to Value your Business to Investors

Working out the value of your business is important when selling your business, as it can help you decide on the selling price. Here are some suggested steps to help you through the process. They measure on both the intrinsic and implicit value.

1. Prepare your business information

You’ll need a range of business information to value your business properly. If you need help with preparing your documents and can’t afford a professional, consider asking friends or family with bookkeeping or business experience.

Buyers/Investors may ask if they can value your business independently, so it’s a good idea to have your business documents organised and up to date (it makes a good impression too!).

Below is a guide to the type of information you’ll need.

Finances and assets

Your financial statements (for the last 5 years if possible) – such as cash flow statements, debts, annual turnover, and profit and loss statements

Details of physical assets – such as machinery, buildings, equipment, and stock

Details of other assets – such as goodwill towards the business and intellectual property (any designs or ideas that you have protected through copyright)

Legal information

Legal documents – such as leases and insurance policies

Registration papers – such as business name certificates, registration papers, licenses, permits, and any other papers that demonstrate you comply with government requirements

Business profile, procedures and plans

Market conditions – such as details of competitors, and how your business compares to them.

Sales information – such as reports and forecasts

Business history – such as start date, ownership changes, and location changes

Business procedure documentation – such as marketing, staff roster and customer service procedures

Business plans – such as marketing, emergency management and growth plans

Other details – such as opening hours and whether the business premises are owned or leased

Staff, supplier and customer information

Employee details – such as job descriptions, skills and experience, work history, performance reviews, and pay rates

Supplier details – such as supply agreements and supply prices

Customer details – such as customer numbers, customer profiles and direct marketing activities

2. Decide whether to get professional advice

If you can afford to, consider getting professional advice on how to value your business through your accountant, a business advisor or a business broker.

These professionals can help you analyse your business finances, find trends within your industry's market, and help you work out a value for your business. They can also help you calculate the goodwill value of your business and estimate your business' future profit.

An advantage of using a professional is that they may have clients who would be interested in buying your business, saving you the cost and hassle of advertising.

3. Choose a valuation method

Below are some common methods of working out the value of a business - this list is not exhaustive. If you engage a professional, they can help you decide which method is best for your business and explain any industry specific methods relevant to your business.

Keep in mind that there is no one set method, and a combination of methods can be used to arrive at your desired sale value. You may also need to negotiate the method of valuation with the buyer or the financier.

A. Look at current marketplace value and your industry

How you value your business can depend heavily on the industry you're in, and the current marketplace value of similar businesses within that industry.

Industries usually come up with their own rules and formulas to value a business, so it's a good idea to conduct research to gain a good understanding of your industry before you sell your business.

B. Use the return on investment method to calculate value

The return on investment (ROI) method uses your business' net profit to work out the value of your business.

To get your ROI, divide the net profit (before owner's salary) by the selling price:

ROI = (net annual profit/ selling price) x 100

For example, you have a selling price of $200 000 in mind, but want to test your ROI based on that price. You calculate that your business' net profit was $50 000 for the past year.

To work out the ROI, you use the formula:

ROI = (50 000/200 000) x 100

In this case, your ROI is 25%.

If you have an ROI in mind, you can use it to calculate the price for your business:

Selling price = (net annual profit / ROI) x 100

For example, if you were looking for a ROI of at least 50% for the sale of your business, and your business' net profit for the past year was $100 000, you can work out the minimum selling price you should set.

Selling price = (100 000/50) x 100

In this case, to achieve a ROI of at least 50%, you'll need to sell your business for at least $200 000.

C. Use your business' assets to calculate value

When calculating your business' asset value, it's important to include both tangible and intangible assets of your business. Tangible assets are physical things you can touch such as tools, equipment, and property. Intangible assets are things that can't be touched but are still valuable such as intellectual property, brands and business goodwill.

After you've calculated the total asset value of your business, you can then use this value as an indication for how much you would like to sell your business for.

As assessing your business' assets value can be a complicated process, it's a good idea to talk to your business advisor or accountant for help.

What is business goodwill?

Business goodwill is an asset that is much harder to value, as it does not have a determined market price. Goodwill can include:

• customer loyalty and relations
• brand recognition
• staff performance
• customer lists
• reputation & approach of your business
• Business operation procedures
• Access to markets
• Strategy

Calculating goodwill can be a complicated process, and different methods will give different results. Using different methods of calculation can give you an indication of the price range you would like to set for your business goodwill, and ultimately the value is what the marketplace or buyer is willing to pay.

Because it's difficult to calculate goodwill, it's a good idea consult a professional such as your accountant.

Take depreciation into account

If you use your business assets to calculate value, remember to take depreciation into account. Depreciation is the loss of value for your assets over time. For example, you may have purchased a computer for your business three years ago for $1000. When calculating your business' asset value, the value of the computer will no longer be $1000 as it was when you purchased it.

Talk to your accountant if you're unsure about how to work out depreciation of your business assets.

D. Find out the cost of creating your business from scratch

The cost of creating your business from scratch can be used as a benchmark for valuing your business. This is the estimated cost to build a similar business in your industry from scratch within the current market. To calculate the cost, you'll need to include all costs related to starting from scratch, including the costs of:

• buying stock
• buying equipment and tools
• getting licenses and permits
• recruiting, training and employing staff
• developing products
• marketing and promotion
• buying or leasing premises
• Setting up an online presence etc.

E. Estimate the future profit of your business

For a buyer, the biggest value of your business will come from future profits generated. As a seller, you're more likely to sell at a higher price if you can show through your financial statements that your business is likely to be profitable in the future.

This helps give a prospective buyer an idea of the returns they may expect from your business in the future.

You can estimate the future profit of your business by looking at any trends in your business finances from past years. You can also investigate the trends of similar businesses in your industry to see how your business compares and how the market is going. This information may be useful when negotiating the final selling price of your business.

What to do...

Talk to your business advisor, solicitor, accountant or business broker for personalised assistance and advice on valuing your business.

Check out our advice & support page for links to business advice, support and counselling services.

Learn more about financial reporting in our business finances topic.

Interested in more business valuation advice? Follow us on Twitter @gbshconsult

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