How do you calculate the value of a business in the UK?

If you’re considering selling your business, trying to raise money, merging with another company, or planning for the future, having an expert opinion on its worth might be helpful.

A business valuation is essential information to have on hand to perform all of the above activities for your company. You shouldn’t undervalue your company at the risk of turning off potential investors or buyers, but you shouldn’t overvalue it.

In this comprehensive article, we’ll discover the definition and factors that affect business valuation in the UK and how to calculate the value of a business in the UK.

Business valuation in the UK

It provides you with long-term insights into the health and vitality of your company, much like a physical test. So, your knowledge of business valuation in the UK must be comprehensive. This section will help you understand the concept better.

Understand business valuation in the UK

A business valuation in the UK is a method for estimating the monetary value of a company. When calculating an accurate worth, a valuation will look at various factors, including the company’s asset inventory and cash flow.

There is no best way to arrive at a business valuation. Combining multiple approaches for a more holistic picture is common practice. If you are interested in conducting a business valuation in the UK, it is a good idea to seek the advice of an independent, specialized financial services professional with previous experience working in specific industries.

Importance of business valuation in the UK

Determining a company’s market value is the basic goal of a business valuation. Becoming proficient in this area can be advantageous for multiple reasons:

• You can use the valuation information to make better decisions by highlighting the company’s strengths and areas for improvement.
• Investors can get a more accurate picture of your company’s value with its help.
• You may have to include information about your business worth on your tax return.
• Knowing your business’s value can help you set a reasonable selling price, negotiate with potential buyers, and secure advantageous financing deals.
• Finding out how much your company is worth can give you a better picture of its financial situation and allow you to put more energy into fixing the things that matter to you.

How to value a business in the UK?

There are numerous approaches to determining a company’s worth. This section will introduce how to calculate the value of a business in the UK.

Business Valuation Methods in the UK

Valuations use multiple approaches to provide a more complete estimate. Let’s discuss how to value a business in the UK using the most common methods.

Entry Valuation

One way to value a business in the UK is to look at the Entry Valuation Framework. This model uses the initial investment needed to launch a comparable venture. This method may work for niche or newly formed businesses. Still, established companies with a track record or heavy competition may do better with other, more conventional approaches to business valuation in the UK.

Example – Entry Valuation Method for business valuation in UK

Suppose a small startup company, “GreenTech,” specializes in eco-friendly products. Let’s use the Entry Valuation Method for its valuation:

Step 1: Calculate the Entry Cost

To calculate the entry cost, we need to estimate how much it would cost to set up a similar business to GreenTech from scratch. This includes:

• Start-up fees – £10,000
• Recruitment and training costs – £20,000
• Tangible assets (e.g., equipment, inventory) – £50,000
• Development of products – £30,000
• Marketing and advertising – £15,000
• Other costs (e.g., office setup, utilities) – £10,000
• Total Entry Cost – £135,000

Step 2: Consider Potential Savings

Now, let’s assume that GreenTech has already streamlined some processes, which could result in potential savings if someone were to start a similar business. For example:

• Streamlined recruitment process – £5,000
• More efficient marketing strategy – £3,000
• Better negotiation with suppliers – £2,000
• Total Potential Savings – £10,000

Step 3: Calculate the Entry Valuation

Entry Valuation :

• =Total Entry Cost – Potential Savings
• =£135,000 – £10,000
• =£125,000

Applying the Entry Valuation Method, we estimate the value of GreenTech to be £125,000. This figure represents the potential cost of setting up a similar business from scratch, taking into account the savings GreenTech has already achieved.

Discounted Cash Flow (DCF)

Due to its reliance on future-looking assumptions, this approach can be more complex. This calculation attempts to determine the present value of the future cash flow, presuming that inflation will cause one pound to be worth more today than tomorrow.

You can calculate this by summing the projected dividends for the subsequent 15 years or more, with a residual value remaining after the period. Apply a 15%–25% discount rate to get its current value.

Example – DCF Method for business valuation in UK

Let’s say we have a cycle business in the UK, and it generates annual cash flows.

• Projected Cash Flows:
  • Year 1 – £100,00
  • Year 2 – £110,000
  • Year 3 – £120,000
  • Year 4 – £130,000
  • Year 5 – £140,000
• Discount Rate – 10%.
• Calculate Present Value – Using the discount rate, you can calculate the present value of each year’s cash flows. The formula for present value is: PV = Cash Flow for a specific year/ (1 + discount rate)^year
  • Applying this formula to each year’s cash flow, we get:
    • Year 1 – £90,909
    • Year 2 – £90,909
    • Year 3 – £90,158
    • Year 4 – £88,792
    • Year 5 – £86,929
• Calculate Terminal Value:
  Terminal Value = Final Year Cash Flow * (1 + g) / (r – g) where r is the discount rate and g is the perpetuity growth rate.
  Let’s assume a perpetual growth rate (g) of 3%. Using the cash flow projection for Year 5 (£140,000) and the discount rate of 10%: Terminal Value = £140,000 * (1 + 0.03) / (0.10 – 0.03) = £2,060,000
• Discount Terminal Value: Discount the terminal value back to its present value using the same discount rate.
  Terminal Value PV = £2,060,000 / (1 + 0.10)^5 = £1,279,098
• Calculate Total Present Value: Sum up the present values of the cash flows and the terminal value to get the total present value:
  • Total PV = £90,909 + £90,909 + £90,158 + £88,792 + £86,929 + £1,279,098
  • Total PV = £1,726,795

Hence, the value of the business is approximately £1,726,795.

Asset valuation

An asset valuation is a must if your company has significant assets.

There are two main kinds of assets:

• Tangible
• Intangible

Net Book Value (NBV) = Physical + Intangible assets – The sum of all its liabilities

It is wise to update your asset records with factors like inflation, depreciation, and appreciation to maintain accurate asset valuations. Asset valuation may not be the best assessment method if a company has many intangible assets. It’s because it may not account for its potential growth and future worth.

Example – Asset Valuation method for business valuation in UK

Suppose we have a manufacturing company called MetalWorks that specializes in producing high-quality metal products. Let’s estimate MetalWorks’ value using the Asset Valuation Method.

Identify the Assets:

• Factory building – £2,000,000
• Manufacturing equipment – £1,500,000
• Raw materials inventory – £250,000
• Finished goods inventory – £500,000
• Accounts receivable – £300,000
• Cash and bank balances – £100,000
• Trademarks and patents – £400,000
• Goodwill – £750,000

Identify the Liabilities:

• Bank loans – £1,000,000
• Accounts payable – £200,000
• Accrued expenses – £50,000

Calculate the Net Asset Value (NAV):

• Total Assets – £5,800,000
• Total Liabilities – £1,250,000

NAV = Total Assets – Total Liabilities = £5,800,000 – £1,250,000 = £4,550,000

Therefore, the estimated value of MetalWorks using the Asset Valuation Method is £4,550,000.

Times revenue method

Startups and early-stage companies without enough earnings history can use the Times revenue method. This method uses an industry-specific multiplier to determine a company’s revenue, usually over a year.

Unfortunately, this method isn’t the most accurate way to value a business in the UK. The Times Revenue approach ignores a business’s costs and ability to produce a positive net income; revenue isn’t always convertible into profit.

Example – Times Revenue Method for business valuation in UK

Let’s estimate the value of a tech startup in London using the Times Revenue Method.

• Annual Revenue –  £500,000
• Industry Multiplier – A multiplier between 3 and 5 might be appropriate for tech startups with high growth potential. For this example, let’s assume a multiplier of 4.
• Business Valuation:
  • Business Value = Annual Revenue x Industry Multiplier
  • Business Value = £500,000 x 4
  • Business Value = £2,000,000

Price-to-earnings ratio

Price/earnings ratio valuation can be useful if your business has a good track record of profitability. For public companies, divide the market price by earnings per share.

For private companies, you must study similar public companies’ financials and apply their price-to-earnings ratio. You multiply profits by a company’s historic P/E ratio from the financial part of the reports.

Example – Price to Earning Ratio Method for business valuation in UK

Let’s say UK Software Solutions Ltd. has an annual net income of £1,000,000, and industry data suggests that similar software companies are typically valued at a P/E ratio of 15.

• Annual net income = £1,000,000
• P/E ratio = 15

Estimated business value = Annual net income * P/E ratio

Estimated business value = £1,000,000 * 15 = £15,000,000

Therefore, according to the Price to Earnings Ratio Method, UK Software Solutions Ltd. might be valued at approximately £15,000,000.

Comparable analysis

You can easily determine your company’s worth using the comparable analysis method.

It involves comparing your business to industry peers to estimate its value. You can use valuation techniques like enterprise value/EBITDA or price-to-earnings ratio to value a business in the UK. On the other hand, public companies are more liquid and marketable, leading to higher valuations than private ones.

Example – Comparable Analysis Method for business valuation in UK

Let’s consider a UK IT consulting firm, Teal Ltd., and identify comparable companies:

• Company A – Enterprise Value (EV) – £1,200,000, EBITDA: £300,000
• Company B – Enterprise Value (EV) – £1,600,000, EBITDA: £400,000
• Company C – Enterprise Value (EV) – £1,500,000, EBITDA: £375,000

Now, let’s calculate the EV/EBITDA Multiples and their Average:

• Company A – EV/EBITDA = £1,200,000 / £300,000 = 4.0
• Company B – EV/EBITDA = £1,600,000 / £400,000 = 4.0
• Company C – EV/EBITDA = £1,500,000 / £375,000 = 4.0

Average EV/EBITDA multiple = (4.0 + 4.0 + 4.0) / 3 = 4.0

Now, let’s apply this multiple to Teal Ltd.:

• Assuming Teal Ltd. has an EBITDA of £250,000.
• Valuation = Average EV/EBITDA multiple * EBITDA of Teal Ltd. Valuation = 4.0 * £250,000 = £1,000,000

So, the market approach valuation of Teal Ltd. is £1,000,000.

Precedent transaction method

The Precedent transaction method, like comparative analysis, helps to value a business in the UK by looking at how others in your industry have done it.

One downside of this approach is that the data becomes obsolete quickly, so updates are vital to keep up with the market. You may need to discount your valuation for private companies using publicly traded companies as references.

Example – Precedent Transaction Method for business valuation in UK

Let’s consider a software company called “TechSol” which has strong growth potential. Let’s estimate its value using the Precedent Transaction Method.

First, we need to identify recent mergers and acquisitions involving companies similar to TechSol. Some potentially comparable transactions could include:

• Acquisition of Company A by Acquirer X for £100 million (EV/Revenue multiple of 5x)
• Acquisition of Company B by Acquirer Y for £150 million (EV/EBITDA multiple of 15x)
• Acquisition of Company C by Acquirer Z for £75 million (EV/Revenue multiple of 4x)

Second, calculate the valuation multiples:

• Company A – £100 million / £20 million revenue = 5x EV/Revenue
• Company B – £150 million / £10 million EBITDA = 15x EV/EBITDA
• Company C – £75 million / £18.75 million revenue = 4x EV/Revenue

Apply Multiples to TechSol:

• TechSol has £30 million in revenue and the average EV/Revenue multiple is 4.5x:
  • Estimated Value = £30 million revenue x 4.5x EV/Revenue multiple = £135 million

Therefore, based on the Precedent Transaction Method, TechSolutions could be valued at approximately £135 million.

What are the factors that affect business valuation in the UK?

The worth of a company is susceptible to many influences. Here are a few factors that affect business valuation in the UK:

• Market conditions and economic trends – A business’s value depends on the economy, market demand, and the state of its industry. However, certain circumstances can also have a big effect. There is a lot of uncertainty right now due to the impacts of Brexit on companies in the UK. Values can plummet as a result of insufficient investment in this.
• Industry-specific factors/ industry trends – The possibility of profitable expansion is an important consideration when selling any company. Maintaining healthy profit margins increases the company’s stability and makes it more resilient to potential market volatility. It shows that a business has much potential for the future and raises its value when it consistently grows and meets its goals and targets.
• Company-specific factors – Since many businesses fail due to insufficient working capital and a weak cash position, showing potential buyers a business with solid cash flows and trustworthy profit projections is a huge deal. Businesses should also use effective and consistent systems to present facts and figures rather than inefficient procedures and weak internal controls that don’t produce much useful data.

What are the Common Challenges and Pitfalls to valuing a business in the UK?

Business valuation in the UK has a few challenges. Addressing them earlier in the valuation process helps mitigate potential growth threats and financial implications. Let’s look at them one by one:

• Lack of accurate financial data – Privately held companies often lack accurate financial data because of inadequate accounting systems and infrequent audits of financial statements.
• Subjectivity in valuation methods – Subjective opinions and presumptions are inherent in valuation methods like asset-based approaches, comparable company analysis (CCA), and discounted cash flow (DCF) analysis. Due to this subjectivity, there is a risk of bias and a loss of trust in the business valuation in the UK.
• Influence of emotions and biases – When people have strong feelings for a company or are overly optimistic about its future, it can influence their judgment and cause them to assign inflated values. The same holds for outside parties like investors or prospective purchasers.
• Legal and regulatory complexities – Accurate business valuation in the UK can be extremely challenging due to the complexity of Tax laws, Regulations specific to certain industries and Contractual obligations. Inaccurate valuations and possible legal consequences may result from ignoring these complexities.

Use Eqvista’s Valuation Services for Precise Reports!

The real worth of a business depends on the amount that an individual or entity is willing to invest in its purchase. You should begin by drafting a thorough business plan that details your intended outcomes and targets. Consulting a financial professional is wise if you need assistance in arriving at a reasonable business valuation in the UK.

Eqvista offers accurate valuation services tailored to every business requirement. Our platform streamlines collecting data, choosing customized valuation methods, and presenting precise reports. The reports give real-time insights into the business’s growth potential and market trends. Once you acknowledge your interest in working with us, you will have dedicated staff to guide and assist you throughout the process. Call us right now to get started!