How to value a UK business in six simple steps

Business valuation is the process of assessing everything (positive and negative) about a business and calculating its monetary value.

Valuing a business isn’t as simple as looking at its cashflow and latest balance sheet. There are different approaches and measures you can use, accounting for tangible and intangible elements and with different scopes.

In this article we want to untangle the complex idea of valuation and put it in simple terms, step-by-step.

If you need to value a business, you’re likely to be on the cusp of an important moment in its history. It’s vital that you get it right – and that starts with properly understanding the process. 

 

Why is an accurate valuation so important?

You might be looking at acquiring or merging with another business, selling your own business, succession planning, introducing a new shareholder or raising investment. Whatever the case, you’re going to need a valuation - and you need it to be accurate.

Getting a reliable valuation prevents you from overpaying or being underpaid, protecting all parties involved in any potential transaction.

An accurate valuation is the bedrock of any big change to a business’ ownership and structure. An inaccurate valuation could have major ramifications for multiple parties, losing you a lot of money or causing legal issues for investors.

 

The most common ways to value a business

Valuations are complex, with lots of constituent parts to be included. As a result, there are multiple ways to approach a valuation. All of the models listed below are legitimate ways of valuing a business, but each has its pros and cons. We’ll share a balanced view on each option below.

 

1) Book value, net asset value and equity value models

• Good for: simplicity and asset-heavy businesses

• Falls short on: capturing future potential, being based on past performance

These three approaches are, for the most part, the same. Calculating book value is possibly the easiest way to value a business, but it’s limited in its effectiveness.

To run a book value calculation, you subtract a business’ liabilities from its assets, optionally excluding intangible assets, as shown on its latest balance sheet. This gives you the book value – in other words, the value of all its assets as listed in its accounts.

It doesn’t account for cashflow, pipeline, historical performance or any other external factors. It’s a purely physical, literal interpretation of what the constituent parts of a business cost.

 

2) Entry valuation model

• Good for: a quick valuation and clear comparison

• Falls short on: only capturing a snapshot in time, rather than longer-term value creation and growth

This approach aims to quantify what it would cost to create a like-for-like business and enter the market from scratch.

You’ll need to calculate everything that a startup would need to mimic your business – from hard assets to product development. Then, you’d look for potential efficiencies against the process you followed (e.g. using a faster process or tool) and subtract those savings from your outlined cost. The end result is your entry valuation.

Entry valuation doesn’t account for the intangibles of reputation, established processes or strength of customer relationships and pipeline.

 

3) Discounted cashflow

• Good for: understanding future value and projecting return on investment

• Falls short on: complexity, risk from unforeseen circumstances and conservative or liberal discount rates

Discounted cashflow (DCF) predicts the future value of a business based on its expected and continued income flows. It puts the future value of its earnings into a present-day valuation.

Relying on estimates and forecasts is forward-looking and, as a result, cannot be guaranteed. This is why a discount is applied to all future cashflows, using a specific formula:

(Future value / present value) ^ (1 / number of months or years in forecasted period) – 1

Putting it into an example, let’s use £10,000 of cashflow, which we estimate to be worth £15,000 in five years.

(15000 / 10000) ^ (1 / 5) - 1 = 0.084 or 8.4%

Applying that discount rate to the present-day value of future cashflows gives us £13,740. If this DCF example was used by an investor, they would know that, in buying the business for no more than £13,740, they should at least break even in five years.

This example is vastly oversimplified and is only used to provide an example of the calculation.

 

4) Market capitalisation

• Good for: valuing large or publicly traded businesses

• Falls short on: providing nuance, accounting for liabilities or considering future value

Market capitalisation is a straightforward model, using a single formula - multiply the share price by the total number of shares in the business.

If a business’ share price is £100 and it has 500,000 shares, its market capitalisation is £50 million.

It’s unlikely that the business could be bought for £50 million, as market capitalisation doesn’t account for cashflow, assets or liabilities. It provides a useful starting point for businesses of a certain size and shareholding structure. 

 

5) Revenue multiplier

• Good for: valuing early-stage and high-growth businesses

• Falls short on: accounting for intangible value in established businesses

Revenue multiplication uses (relatively) short-term revenue generation as the basis for a valuation. It’s a common way to evaluate businesses that are not yet profitable. To use the revenue multiplier model, take one year of the business’ revenue and apply your chosen multiplier.

The multiplier you use should depend on the growth rate of the business, its industry and the wider economy. Landing on a revenue multiplier can take in factors such as market reputation and customer retention. If you’re feeling bullish, this could be something like 3x. If you’re more bearish, you could go as low as 0.5x. Revenue multipliers for startups are typically 7-8x.

Revenue is not the only metric multipliers can be applied to. EBITDA (earnings before tax, interest, depreciation and amortisation) and profit are also commonly considered.

 

6) Comparable analysis

• Good for: setting values in context

• Falls short on: understanding the specifics of the business you’re valuing

Comparable analysis values a business by looking at other businesses. Taking recent sale prices within your industry, comparable analysis gives you a benchmark against which to measure the business you’re trying to value.

It’s effective because it gives you a top and bottom range for valuations, but it doesn’t consider anything specific about the business in question. A business could far exceed its competitors because of a recent innovation or could be valued much lower due to poor financial performance.

 

Many more options available

We recommend doing further research into business valuation methods, as there are plenty more we haven’t mentioned in this article. The British Business Bank has a good list to start with.

You can always combine some of these approaches (eg. comparable analysis + discounted cash flow) to get a clearer picture.

There are also accountants and lawyers who specialise in business valuation, so you don’t have to do it all on your own. We recommend working with a trusted professional, for peace of mind and maximum accuracy, but note that these services come at a cost.

 

How to value a UK business step-by-step

Your approach to valuation will be dictated by the model you choose to use (whether it’s one we listed above or another). Using the model of your choice is the main step in the process, but there are other steps to follow before and after running your calculations.

1) Understand the purpose of the valuation

Your approach and aims with a valuation will depend on your reasons for instructing it. That’s why the very first step you take should be to clarify the perspective you’ll be taking throughout the process.

• Selling your own business

• Acquiring another business

• Taking a shareholding in a business

• Adding new shareholders to your business

• Splitting assets in a divorce or other legal separation

• Conducting succession planning or starting estate planning

 

2) Gather financial information

No matter what approach you choose to conduct a valuation, it’s good practice to gather and review the company’s accounts first. Take the time to go through the publicly available financials so you can pick up on any initial red flags like falling income or rising debt load.

Search the Companies House register to find a business and its published accounts.

 

3) Conduct your analysis

Use one (or more) of the models we’ve listed in this article to generate your valuation, or find another option by doing your own research.

 

4) Consider non-financial factors

Some models account for variables like industry performance, macroeconomic conditions and risks and opportunities beyond the obvious.

There’s not a set process to follow here, but you should spend time thinking about the non-financial factors involved. Value, opportunities and risks aren’t always apparent in formulae alone.

 

5) Adjust for market conditions

Businesses don’t exist in a vacuum. The market a business operates in has a huge effect on its value, while being outside of its direct control.

A travel startup would have been valued much lower in 2020 than in 2019. That has nothing to do with its management or processes, but a global pandemic that brought the world to a standstill.

That’s an extreme example, but the point remains – external conditions affect valuations and need to be taken into consideration.

 

6) Review and validate the valuation

The adage of “measure once, cut twice” remains apt, even if we aren’t doing DIY. A valuation is a serious undertaking and you want to be confident in your calculations. Ideally, you’d bring in a third party to review your valuation and provide another important perspective.

Valuation is an imperfect art, but the more carefully you approach it and the more you can validate your numbers, the likelier you are to reach a fair estimate.

 

Common challenges in business valuation

Valuations are rarely straightforward - they’re a difficult mix of complexity, interpretation and subjectivity.

Given that businesses are usually being valued ahead of a change of ownership, you’re probably doing all of this at the top end of your risk appetite. Knowing and mitigating the common challenges in valuations can only be a sensible idea.

 

Availability of information

Depending on your reason for valuing the business (and how far along in the process you are), you might not have access to all the information you want and need.

Say you’re interested in acquiring a business, you won’t have access to their full financials until you’re in an exclusivity period with certain guarantees in place.

 

Managing uncertainty

Any valuation that tries to account for future revenue or growth involves an element of uncertainty. Even with the best calculations and best- and worst-case planning in place, there are some events that can’t be predicted.

You have to be comfortable with the imprecision that’s inherent with valuations. Most models allow for variance and do what they can to reduce it, but no model is perfectly accurate.

 

Change happens quickly

A valuation can go out of date in no time at all – for better or worse.

Conditions change, markets respond and a business could be worth significantly more (or less) in response to any number of factors.

Some changes can be predicted (eg. pitching to win a lucrative long-term contract), others can’t (eg. if a product goes viral on TikTok and sales grow by 5,000% overnight).

 

Bias and subjectivity

Humans aren’t very good at remaining neutral, especially when there’s money on the line.

It’s to be expected that a vendor will value their business on the higher end of the spectrum and an investor might calculate a much more conservative estimate. One of the best ways to avoid bias (positive or negative) is to instruct third parties for their assistance throughout the process.

 

Small sample sizes

If you’re looking for comparable businesses as part of your valuation, you might not have many options to choose from. Businesses are sold regularly – there were 1,837 mergers and acquisitions over £1 million of UK businesses in 2023 – but the numbers vary wildly between sectors.

You might be involved in a transaction for a business in a relatively static industry. If the last comparable sale was several years ago or for a business of a greatly different size, any comparison you make will be limited in its usefulness.

 

A complex process for an important cause

Valuing a business is hard work, but it’s usually undertaken with good reason. It doesn’t matter if you’re buying, selling, or preparing for fundraising, valuations usually indicate a pivotal time in your business’ lifespan.

There are many approaches you can take (and even combine), some of which we’ve shared in this article. There’s not a single, golden rule to follow – businesses are far too complex and unique for that.

Above all else, you want to choose the model that, in your opinion, represents your business fairly and accurately. Working with a third party can make the process easier.

The only other thing left for us to do is to wish you the best of luck with your valuation!

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