What is the business worth?

The valuation of private companies is not an exact science – every business is unique and a multitude of factors affect the valuation.

All companies will have a standalone value, i.e. what it is worth if it continued to operate as an independent business. This is usually the value at which a management buyout is carried out.

It is important to understand that a business sometimes has a higher value to a trade buyer – the strategic value.

Using our transaction expertise, we take time to properly understand each company and to arrive at a commercial value.

How are companies valued?

There are different methods for valuing companies used in different circumstances. However, when a profitable business is being acquired, the company is usually valued based on the future maintainable operating profits the company is expected to generate and the valuation is usually expressed as a multiple of profits. This is called a cash free / debt free valuation.

The level of the multiplier primarily reflects the growth potential for the company, but also reflects its overall quality and the perceived level of inherent commercial risk.

The underlying operating profits are after adjusting for one-off factors, profit extraction by the current owners and after allowing for a fair cost in respect of management.

Debt and cash free adjustments

The valuation method above calculates the value of a company including all of the assets and working capital required to generate the underlying operating profits.

It is common for companies to hold freehold property and surplus cash on their balance sheets, which increases the value of the shares.

Conversely if the company contains debt, this will reduce the valuation.

The “strategic premium”

Some trade buyers may be willing to pay over and above what a company is worth on a stand-alone basis – what we call a strategic premium. This is because some buyers can generate additional value from an acquisition through:

• Cross selling products or services
• Accessing new markets
• Realising economies of scale
• Making cost savings
• Removing a competitor
• Securing a key customer or supplier

In some cases this additional value can be substantial. In other cases, there will be no significant strategic premium.

Even if a trade buyer may be willing to pay a higher price than a management team could afford, there are reasons why many owners choose to still sell to their management teams. These can include ensuring the business continues as an independent company, securing the employment of staff, rewarding loyalty of managers and avoiding the uncertainty associated with selling to an external party.