How to value your business for investors and buyers

Every financial event in a small business’ life involves the determination of the company’s value - whether it’s raising additional funds, qualifying for loans or transferring ownership.

Regardless of where you are in your business life cycle, you must always have its value at your fingertips.

Being confident in your business value helps you to accurately pitch to investors and raise capital, or price your business to buyers.

If you’re looking to buy an existing business, you should also be able to independently estimate its value to pay the right price.

Business valuation represents your company’s total worth. It takes into account your earnings, assets, debts and losses. Even if you aren’t planning to sell, buy or raise funding for your business, being aware of its value can help inform your company’s road map, and future exit strategies.

Here are some essential keys and steps to determining the value of any business:

Forget about capital assets

You might have made the common mistake of equating asset value with business value. These two entities are completely different. For example, let’s say your business owns equipment worth Sh500,000, supplies worth Sh100,000 and financial backing of Sh200,000. It means you’ve got Sh800,000 in capital assets. If you were to sell everything owned by your business, that’s the amount you’d expect to make.

However, that isn’t the only thing that counts towards business valuation. A buyer is interested in how much money they can make through your business products and services, not simply how much its assets are worth.

Determine your gross income and outgoing payments

So, if your business capital assets don’t determine your business value, what does? The answer is profits.

A company’s valuation is all about how much money you’re making now and how much you’re going to make in the future. A buyer wants to know how much money they’ll make if they buy your business.

Your own salary is included in the gross revenue and outgoing payments. However, we’re not talking about every penny you make from the company; rather, about your base operational wage.

Net profit is what we are aiming for

A company is unlikely to generate the exact profit each year. To have an accurate valuation of your business, you have to determine the amount of growth or profit or loss you can expect over your applied multiple. To do so, examine historical and financial data for your company, your market’s expected growth and your competitors’ progress.

Calculate your business value

Now it’s time to actually calculate your business value. First, establish your business net income. Take the gross profit and subtract all expenses.

Second, calculate the profitability of your business in multiples. While some guesswork is involved, you can get an accurate calculation by researching your industry, looking at your financial history, your customer base and your relationship with suppliers.

You should also take into account your market as it affects your profitability in the coming years. For instance, if your business is in an established and stable market, you can use historic figures because it’s unlikely that there will be a lot of movement. However, if you’re in a new market, there’s an opportunity to increase your numbers considerably.

Determine your potential growth rate by comparing it against general market growth. For example, if your market grew by 15 per cent in the previous year, and your business grew by 14 per cent. That provides evidence to investors and buyers that they can expect similar growth levels as those predicted by industry experts.

Don’t forget market valuation

The valuation you’ve arrived at with the steps above can give investors and buyers a reasonable understanding of your business value. However, it doesn’t mean that your business is actually worth the figure you’ve arrived at.

Ultimately, your business is worth the market valuation. Actual market value takes into account the assessment of other parties using all the information available about the business and the industry.

How much will a buyer actually be willing to pay for your business? If you’ve valued your business at Sh10 million but buyers and investors are only willing to value it at Sh5 million, then that is its market value. The market ultimately dictates your business’ overall value.

You may have to compromise your figures to account for the market valuation. If you want to sell your business or are looking for an investment, you can’t afford to be stubborn with your numbers.

Always bear in mind that business is about leverage. Put your best foot forward in negotiations to get the best out of the deal.