If you've built a business and you're starting to think about stepping back, one of the first things you'll want to know is what it's worth. Most owners have never had their business valued. The first figure they hear, from a friend, a broker or something they've read, tends to stick.
This guide explains how to value a business in the UK the way buyers do. For most profitable, owner-run businesses, the value comes from profit. A buyer takes the profit the business makes in a normal year, adjusts it to show what a new owner would earn, and multiplies it by a figure that reflects how confident they are that the profit will last. Then they add any spare cash in the business and take off any debt.
The rest is detail, but it's detail that can move the number a long way. Two businesses with the same profit can sell for very different prices, and the reasons are usually things an owner can work on.
How to value a business based on profit
Most valuations of owner-run businesses follow three steps.
- Work out the profit a buyer can rely on. This is the profit from a normal year, adjusted for anything that won't carry on under a new owner. You'll sometimes hear it called maintainable profit.
- Apply a multiple. The adjusted profit is multiplied by a figure that reflects risk and growth. The lower the risk, the higher the multiple.
- Adjust for cash and debt. Spare cash is added, debt is taken off, and the money tied up in day to day trading is checked against a normal level.
Buyers usually look at the last three years of accounts and the current year's management figures. A business whose profit has risen steadily is easier to value than one that jumps about, and one good year on its own won't carry much weight.
Adjusting the profit comes first
The profit in your accounts is rarely the profit a buyer will use. Accounts for an owner-run business are usually prepared for the tax return, and they aren't designed to show a buyer what they'd earn. So the first job is to adjust them. Buyers' accountants call this normalising the profit.
EBITDA, in plain words
You'll hear buyers talk about EBITDA. It stands for earnings before interest, tax, depreciation and amortisation. In plain words, it's the profit the business makes from trading before the cost of any loans, before tax, and before the accounting charges that spread the cost of equipment, vehicles and past purchases over several years.
Buyers like it because it lets them compare businesses however they're financed. It isn't the whole picture, though. If your vans or machines will need replacing soon, a buyer will count that, because the cash still has to be found.
What you pay yourself
This is often the biggest adjustment. Many owners of limited companies pay themselves a modest salary and take the rest as dividends. Dividends aren't a business cost, so they don't reduce the profit in your accounts. A new owner, though, will usually need someone to do your job, and paying them means a market salary, plus employer's National Insurance and a pension. That cost comes off the profit.
It can work the other way too. If you pay yourself more than the role would cost, or there are people on the payroll a new owner wouldn't need, a buyer may add the difference back.
One-off and personal costs
Costs that won't happen again can be added back, such as a legal dispute that's now settled or a one-off repair. So can costs that are really the owner's, like a car the business pays for that nobody else uses. Buyers will want evidence for each one, so it's worth asking your accountant to list them before anyone else looks.
A made-up example shows how the adjustments can pull in both directions. Move the slider to see how much the cost of replacing you changes things.
The profit a buyer uses is rarely the profit in your accounts
Adjusted profit: £150,000, compared with £150,000 in the accounts.
The owner here might have quoted £180,000. A buyer would bring it back to £150,000 once a manager is paid to do the owner's job. To put your own figures through the same steps, use our adjusted profit calculator.
Choosing the multiple
The multiple is a measure of confidence. It reflects how sure a buyer is that the profit will carry on, and whether it's likely to grow. A business that would run well while the owner took three months off, with customers on contracts and a growing order book, earns a higher multiple than one that relies on the owner and a handful of customers.
There's no single multiple for UK businesses. BDO publishes one of the best-known indexes, the Private Company Price Index, which tracks the multiples of EBITDA paid by trade buyers and investors for UK private companies. BDO says its figures are averages and should be adjusted for things like sector and size. The Institute of Chartered Accountants in England and Wales (ICAEW) describes indexes like this as general guides or starting points, and notes that some leave out loss-making companies, which pushes the average up.
Size matters in its own right. Invest Northern Ireland's business guidance notes that smaller businesses are usually valued at a lower multiple than similar, larger companies, which is worth remembering if you see a multiple quoted for a much bigger firm in your sector.
Cash, debt and working capital
When a buyer makes an offer, the headline figure is normally for the business on a cash-free, debt-free basis. What you receive for your shares is that figure, plus the spare cash in the business, less any debt, adjusted up or down if the working capital isn't at a normal level.
Working capital is the money tied up in running the business from day to day. Broadly, it's your stock and what customers owe you, less what you owe suppliers. A buyer expects a normal amount to be left in the business on completion day so it can carry on trading. That normal level is negotiated with the buyer, and BDO points out that it's in the seller's interest for it to be as low as can be justified. If you chase in every debt and hold off paying suppliers in the last few weeks before the sale, the adjustment takes it back.
As a made-up example, a business valued at £1,000,000 on its profit, with £200,000 of spare cash and a £150,000 bank loan, would bring its owner about £1,050,000 before tax and any working capital adjustment. How much of the cash is really spare is often argued over, so it helps to settle that early.
Why turnover is usually the wrong place to start
Plenty of owners ask how to value a business based on turnover, partly because turnover is the number they know best. For an established, owner-run business it's usually misleading, because turnover says nothing about what's left once the costs are paid.
Take two made-up firms that each turn over £2,000,000 a year. One makes £300,000 of adjusted profit. The other makes £40,000, because its margins are thin and its costs have crept up. A buyer would value them very differently, and any rule that gave them the same price would be wrong for at least one of them.
For a business that's been trading profitably for years, turnover is more useful as a check on its size and growth, and on how its margins compare with others in the sector.
When a business is valued on its assets
An asset valuation starts from what the business owns, less what it owes, as shown in the accounts. That figure, the net book value, is then adjusted to reflect what the assets are worth today, such as a building that's gone up in value or customer debts that won't be paid.
It suits stable businesses with a lot of physical assets, such as property or manufacturing firms, and businesses that make little profit. For a profitable business, the asset value is more of a floor. What a buyer pays above it is for goodwill, meaning the customers, the reputation and the team that produce the profit.
What pushes the value of a business up or down
Once the profit is agreed, much of the discussion is about the multiple, and that comes down to risk. These are the things buyers look at most closely.
How much it relies on you
If customers ring you, suppliers deal with you and the team waits for your decisions, a buyer has to ask what happens when you leave. They'll either pay less or tie more of the price to you staying on for a while. A manager who runs the day to day, and ways of working that are written down, make the business easier to value and easier to sell.
Your customers
A business where one customer brings in a large share of sales is riskier than one with hundreds of smaller customers, because losing that one would hurt the profit badly. Income that repeats, through contracts, subscriptions or customers who come back year after year, is worth more than income you have to win again each month.
Growth, sector and size
A business that's growing, with room to grow further, is worth more than one that's standing still. The sector matters too, because some sectors attract plenty of buyers and others attract few, and more interested buyers usually means a better price. Size plays its part too, as covered above.
The team below you
Buyers look closely at who'll still be there after you've gone. They'll want to know whether there's a manager with a good record and how experienced your senior staff are. A settled team with someone ready to step up is one of the clearest signs that the profit will carry on.
Property
If your company owns its building, a buyer will often value the property and the trading business separately. You might sell the building with the business, keep it and rent it to the buyer, or move it out of the company before the sale, which has tax consequences worth checking first. If you keep it, the buyer will take a market rent off the profit. If the business pays you less than a market rent today, expect that to be adjusted too.
A valuation is a range, not a price
Any valuation you or your accountant put together is an estimate. Invest Northern Ireland's guidance makes the point that owners often place too high a value on their business, and that in the end it's worth what a buyer is prepared to offer. Buyers often use more than one method to reach a range, and the price itself is agreed by negotiation.
How the price is paid matters as well as the figure. Part might be paid at completion, part later, and part only if the business hits targets after the sale. Those terms are set out in heads of terms. The price also isn't what you keep. If you sell shares at a gain, you'll usually pay Capital Gains Tax, though Business Asset Disposal Relief can reduce the rate on qualifying gains.
If you'd like a sense of what your business is worth today, our valuation tool gives a rough range in a few minutes. Use it to see whether a sale would give you what you need, then talk to your accountant about the adjustments. Our guide to how to sell a business covers what comes after.