Business Valuation Tool Important note There is no definitive valuation methodology for a business, since most models rely upon various subjective assumptions. Whichever valuation model you use, or assumptions you make, ultimately the value of the business comes down to what both parties agree it is worth. Start-up businesses (especially pre-revenue ones) can get very carried away with high business valuations. Think -would someone buy what you have created so far at this valuation? -probably not. Usually, you will show the valuation of the business as a range, by changing the key assumotions in the model. There are various models which can be used to value a business. Outlined briefly below are some of the more popular models together with a brief explanation on each. Net Asset Valuation Model This is the most basic form of valuing an existing business, which looks at the Net Asset Value as shown on the balance sheet i.e. all assets of the business, less liabilities. Comment The most basic model, but it does not account of the future earnings capability of the business and its assets 'Sweat Equity' Model (see other worksheet) The value of the business corresponds to the total equity injected, plus an amount for the entrepreneur's time taken to develop the idea. Comment A fairly basic valuation model with relatively few assumptions and variables. Price /Earnings Model (see other worksheet) This model is useful to estimate a valuation at the exit point e.g. after 3-5 years, to provide an estimate of the investors' return on investment. For a quoted company, the price/earnings ratio is the quoted share price of the company divided by the (usually 1 year forecast) earnings per share. Find an appropriate P/E ratio by (1) comparing your business to similar quoted businesses (2) discounting the ratio (sometimes significantly) to reflect the reality that your business is worth less than a quoted counterpart. Once you have established a P/E ratio, you multiply the business’s projected annual net profit after tax (earnings) by this figure, in order to assess the value of the business (price). For example, if the P/E ratio is 6 and your projected earnings are £100,000, your P/E valuation for the business is £600,000. This assumes that the future earning of the business are £100,000 per year. Comment Determining a P/E ratio for your business can be a very subjective exercise. Discounted Cashflow (DCF) Model An investor purchasing shares in a business is, in affect, purchasing a share of the business’s future cashflow (in the long run broadly represented by profits after tax) The DCF model discounts this cashflow back to a single figure, to derive a value for the business, using an assumed discount rate. The discount rate should reflect an investor's desired investment return over the life of the investment Comment Again, the choice of discount rate is crucial and highly subjective Sales and Profit Multiples A simple method which multiplies the sales or profits at exit by a multiplier. The multipliers are based on industry standards or sales of comparable businesses. Comment A good way of testing the reasonableness of other valuation methods, although again the multipliers are subjective. © enbusiness 2003. All rights reserved.Simplified Business Valuation (Price /Earnings Ratio Model) You can change the cells in yellow. Valuation at Yr 1 (Financial Injection) Third party investment £350,000 The amount injected by an equity provider (investor). Percentage share of the business 35% This percentage to be negotiated. Adjust this figure until a CAGR of at least 30% is achieved. Post-money valuation of the business £1,000,000 The investment divided by the percentage share of the business -this is what the investor must believe the business is worth now. Implied pre-money valuation £650,000 This is the business value implied pre-investment. This is a key figure. Do you really think that your business is worth this now? Would someone buy it from you at this price? If not, then why should someone invest at this price? Valuation at Exit Point Exit at end of year 3 Earnings (Profit) After Tax, taken from Financial Forecasts for yr. 4 450,000 £ By convention, you should use the earnings for the year after the exit year (if you are using a forward P/E multiple -see below). Valuation at Exit Point P /E Ratio High 7 3,150,000 £ You should use a forward P/E multiple, i.e. one which is based on the 1 year forecast earnings of your comparable company or sector. Med 5 2,250,000 £ Stock market research will need to be undertaken to establish a realistic P/E Ratio for your sector, which is then discounted. Low 3 1,350,000 £ As a very rough guide, P/E ratios for small businesses can be discounted to about half (or even less) those of larger enterprises. Investor Return on Investment Assumes Medium P/E Ratio £ Total % ROI Investment 350,000 £ Year 3 787,500 £ 225% Investors will be looking for a CAGR of at least 30% and maybe a lot more than this depending on market conditions. © enbusiness 2003. All rights reserved. CAGR (compounded annual growth rate) of initial investment Value of investment 31.04%Simplified Business Valuation ('Sweat Equity' Model) Financial Injection Notes You can change the cells in yellow. Entrepreneur equity -cash 25,000 £ equity -guaranteed loan 50,000 £ 1,2 i.e. a loan to the business by a third party, but personally guaranteed and secured over assets by the entrepreneur. Total 75,000 £ This represents the entrepreneur's total financial risk. Investor A equity -cash 75,000 £ B equity -cash 50,000 £ C equity -cash 20,000 £ 145,000 £ Total Financial Injection 220,000 £ Sweat Equity' -Entrepreneur Salary forgone (annual) £50,000 No of months on project 6 25,000 £ 3 For the idea 20% 44,000 £ 4 69,000 £ Business Valuation 289,000 £ Percentage share of the Business Entrepreneur 49.83% A 25.95% B 17.30% C 6.92% 100.00% Notes 1 If your financial forecasts show the debt repayment serviced by the business, as opposed to you as a shareholder, an investor may say that this should affect the valuation (in their favour), since the capital cost of your investment is being re-paid by the business. 2 Arguably, even though you are not putting this amount into the business in cash, this is still quasi equity as you are risking this amount. If the business goes bust, you will be responsible for paying this amount to creditors. 3 This is the first component of the ‘sweat equity’ and represents the personal sunk-cost investment you have made, in terms of the opportunity cost of your time, in getting this business up and running. In this model, this has been treated as a quasi-equity injection by you, since arguably, the business could not launch without you having invested this time in the initial stages. This figure is notional for valuation purposes only and should not appear on the balance sheet. 4 This is the second component of the ‘sweat equity’ and is an arbitrary figure for coming up with the idea and is estimated as a percentage of Total Financial Injection. This figure is notional for valuation purposes only and should not appear on the balance sheet. © enbusiness 2003. All rights reserved.