Valuing a Business

Valuing a Business_v1 Dr. Harald Fien 2

Valuing a business
Why?
When is it important to value a business?
When buying or selling a business
When taking in a new partner (in a partnership)
In both situations it is necessary to place a value on the business
The buyer needs to be certain that he/she is getting value for
money
The seller wants a return on the business that he/she built up
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Valuing a business
Selling a business
Owners sell a successful business
To retire. The proceeds of the sale will provide the owner with a pension
To move on to a another enterprise
Some entrepreneurs are serial entrepreneurs. They are successful
in terms of starting business and prefer the challenge of a new
enterprise to continuing to build an existing one
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Valuing a business
How should we place a value on the business?
The first place to look is the balance sheet
This summarises the value of all assets and liabilities
Value can be seen in terms of the asset base
The value of a business is surely the total value of assets (fixed and
current)
after allowing for depreciation
and both current and long term liabilities.
This notion that the value of a business is equal to the value of net
assets is appealing
Nevertheless it is only a small part of the story
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Valuing a business
Limitations of the balance sheet
The balance sheet does not give a complete valuation because:
what it shows is not necessarily an accurate valuation of assets
it does not show some important intangible assets. The balance sheet
rarely records goodwill
Ultimately value is determined by what buyers are willing to pay for
the business
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Valuing a business
Goodwill
Some firms have little in the way of tangible assets
For instance, the fixed and current assets of a self employed window
cleaning business are negligible
What is the value of the business apart from a ladder and bucket?
Now if you were selling such a business you would expect to be
compensated for you work in building up a customer base
This is an example of an intangible asset known as goodwill
Goodwill implies that the buyer is paying for the work that has gone
into building up the business and will have access to the existing
customer base
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Valuing a business
Example - the purchase of The Times
Rupert Murdochs News International bought The Times newspaper
But what exactly did he buy?
The premises in which The Times was produced? But soon after
buying the Times he moved it from Fleet Street to Wapping
The printing presses? But he scrapped these as part of the printing
revolution of the 1980s
No - the assets that were of greatest value were intangible:
contracts with journalists and the brand name
The physical assets were of lesser value than the human and
intangible assets that he acquired when he bought the Times
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Valuing a business
Intangible assets
Intangible assets have no physical form and they are invisible
In these ways they differ from tangible assets such buildings,
machines and stock
Brand names, patent, trademarks, copyright and franchises as well
as goodwill are regarded as intangible assets
One firm might purchase another merely to acquire its patents or
franchises
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Valuing a business
Goodwill
Goodwill arises when a business is sold for more than the balance
sheet value of its assets
A purchaser is prepared to pay more than the asset value for the
business as a going concern since it may have an established name
and reputation as well as a favourable location
Goodwill implies that the business is a going concern and that there
is an additional premium on its value over and above the value of
net assets
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Valuing a business
Negative goodwill
If goodwill = value of the business minus value of net assets then it
is possible that goodwill can be negative
This means that the value of the business is lower than the value of
its assets less liabilities
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Valuing a business
Bases for valuation
Average weekly sales for the previous accounting period x an
agreed figure
Gross annual fees x an agreed figure. In professions it is likely to be
gross annual fees multiplied by a given figure
Average annual net profit x an agreed figure. Here value is a
multiple of annual profits e.g. value is equal to say 3 to 5 years profit
Return on investment e.g. if a 5% return is expected from a business
which earns 20,000 p.a. then the capital value is 20k x 100/5=
400k
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Valuing a business
Valuation of different businesses
Asset rich business
freehold retailer/ agricultural smallholding
value on the basis of market value of tangible assets
Business with no real tangible assets
e.g. a consultancy business.
value as a multiple of profits
Those with a mix of tangible and intangible assets
small manufacturer/ restaurant
assets at valuation plus goodwill value as a multiple of profits
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Valuing a business
Lessons Learned
Why valuing a business?
What is goodwill?
Explain the valuation of different businesses.