How to Value a Business

Being a successful business owner involves having a solid understanding of your business- from its operations to its value. In doing so, you can navigate a potential business sale with confidence.

When it comes to determining the value of their business before a sale, most business owners opt to get their business formally valued. That way, they can gain the necessary insight into what their business might be worth and the next steps to take from there.

What Is A Business Valuation?

A business valuation creates a report by assessing various factors to determine the worth of the business. This report calculates the business’s value by analysing profits, assets, market value, and future earnings to gauge its financial performance.

Generally, a thriving business tends to have a higher valuation.

However, it's important to keep in mind that the valuation approach will vary depending on the purpose. For instance, a valuation report for tax purposes will differ significantly from a valuation conducted for selling the business.

As you might have guessed, for the context of this article, we’re focusing on valuations for the sale of a business.

Valuing A Small Business For Sale

It’s not unusual for business owners to sell their small business. Often business owners will build a business from the ground up, only to sell it and move on to the next venture. It’s a win-win, as there’s plenty of buyers out there looking to purchase a business rather than start one from scratch.

However, selling a business needs to be done the right way. A misunderstanding between the parties involved in the sale is pretty bad for business- this could lead to the sale not going through or worse, legal trouble!

One of the best ways to avoid this situation is to get your business properly valued prior to selling it. That way, the buyer of your business has all the information they need about your business so they can make a clear decision for proceeding.

So, where do we start when it comes to valuing a business?

Valuing your Business For Sale: Key Considerations

When it comes to valuing a business for sale, it is often assumed that the financial aspects alone hold the utmost importance.

This is entirely not true. This misconception fails to recognise the significant influence of non-financial considerations on determining a business's true value. In reality, both financial and non-financial factors intertwine to shape the valuation process.

We’ve listed some of the key, financial and non financial considerations below. Let’s take a look at them.

Customer And Client Contracts

Selling a business often involves all of the businesses current contracts to be transferred over to the new owner. This includes agreements like:

• Commission Agreements
• Supply Agreements
• Privacy Policy
• Hire and Rental Agreements
• Sponsorship Agreements

When you're getting your business valued, the strength, quality and terms of your agreements are going to be assessed. The terms and conditions of these agreements can impact the value of the business because they represent the ongoing relationships and possible revenue streams for the new owner.

Property Leases

If your business is leasing any properties, then your rental agreements will be taken into consideration when valuing the business. Things such as the remaining length of the agreement and any restrictive clauses within the contract can play a role in determining whether the business’s value will increase or decrease.

For example, if the period on the rental agreement ends in the next few months with no option for extension, there’s a good chance this is not going to be an attractive quality for potential buyers, as they will have the added responsibility of finding a new place to rent.

Market Value

How your business fares up to its competitors in the market will determine its sale value as well. When determining your business’s market value, the factors often assessed include:

• Market share
• Customer base
• Competitive advantages
• Brand reputation

Your business's market value will be impacted by all of these things and more. Market valuations also tend to look at other businesses in your industry that have sold in the market. Your business is then assessed against the others in terms of price, growth, potential and size.

Income and Future Earnings

Your business's profits, losses and expenses will play a determining factor in its valuation. If your business has a lot of expenses but very little turnover, this can decrease the value of your business overall. However, if your businesses expenses are reasonable and the profits are high, your business is likely going to be valued well in this aspect.

When getting your business valued before a sale, it's important to be as transparent as possible about your business’s financial performance.

Employees And Management

Your business’s internal systems, such as operations, management, employee relationships and expertise all add to the value of your business. When you sell your business, your relationship with your employees is going to end and you will most likely lose control over how everything will operate within the business.

However, the effectiveness of your current systems will determine whether the business has been set up for success or if significant changes will need to be made. For instance, if you’ve hired well sought after experts as part of your team and built a great relationship with them, the new owner of the business is likely going to want to retain this working environment.

Assets

Your business's assets will play a significant role in determining its value. Both tangible and intangible assets are weighed in. The tangible assets are the physical assets of a business, such as any property your business owns or equipment. Non tangible assets are anything that isn’t in a physical form but still owned by your business. This can include any type of intellectual property and contracts. For example, trade marks and licensing agreements are all no tangible assets. All of these will contribute to the valuation of your business.

I’m Ready To Sell My Business, How Do I Get It Valued?

It’s always best to get your business valued by a reputable third party. That way, you and any potential buyers can be assured the valuation of the business has been done objectively. The valuation should be comprehensive and easy to read. Along with this, it should cover the points we discussed above and much more.

Once you're satisfied with the valuation of your business and are sure it’s looked at everything necessary, then you can go ahead and start preparing for the sale of your business.

It’s wise to seek the help of a legal professional for this next phase. Much like getting your valuation done right, you want your business sale to go smoothly so you and the other party can shake hands and move on, without any complications.

Having the help of a legal professional can take the stress out of selling your business. Check out our Business Sale Package, so you can have the guidance of a legal expert as you complete the sale of your business.

Next Steps

Getting your business valued is something most business owners will need to do, whether it’s for taxation, legal purposes or the sale of a business. If you're engaging in the sale of your business, then the purpose of your valuation must be aimed at a business sale. That way, it can cover everything necessary for the interested party. To summarise what we’ve discussed:

• A business valuation determines the worth of a business
• When valuing your small business for sale, there a number of financial and non financial considerations that come into play
• Once you’re businesses had been properly valued, then you’re ready to move ahead with selling your business
• It’s important to have the help of a legal expert when selling your business to make sure things go well- our experts at Sprintlaw are ready to help!

If you would like a consultation on business sale agreements, you can reach us at 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.