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There are many reasons for doing a business valuation, but one of the main reasons is when a company wants to sell part or all of its business. Another reason is when a company wants to acquire a company or merge with another company. More and more business owners carry out business valuations every year to continuously monitor the value progress in their own company. It is important to start with value-creating activities well in advance of a sale to increase the value of the company.
The valuations provide a good indicator of what the value of the company is today, but also an insight into what you should work on to get as high a value as possible in the longer term. Here you can do a business valuation of your company.
The process of finding the value of a business involves evaluating all aspects of the business and using objective measures.
On this page we answer questions you may have about business valuations, so keep reading or click on the questions below that interest you and get your answer right away.
What is the value of my company?
There are different ways to value a company. Which method is best depends on what kind of company it is and what the purpose of the valuation is. In general, there are a few common main areas to base a business valuation on: assets, relative market value or fundamental value.
When you look at asset valuation, the method is not suitable for all types of businesses. This valuation model is best suited for e.g. property and investment companies as well as young companies where there is limited financial information available.
A net asset valuation is based on the company’s net worth, i.e. the company’s equity. Net worth is the difference between the company’s assets and liabilities, which corresponds to equity. This information is available in the balance sheet, which means that a net valuation is a relatively simple valuation method.
A relative market value only works when there are enough other similar companies to compare your company to. A common measure is the P/E ratio. You simply take a company’s market value and divide it by the company’s annual profit. A P/E ratio of 10 means that it will take the company 10 years to earn today’s market value if profits are kept constant.
Another similar multiple is P/B, where B stands for “book”. P/B is thus the company’s market value in relation to the book equity.
An example of fundamental analysis is the discounted cash flow (DCF) model. This method involves discounting future cash flows to a value today.
A more modern approach to business valuation is instead to discount the company’s future excess earnings. This model is based on available financial statement data, which many perceive to be stable and more readily available than cash flow calculations. Read more about excess return models.
Another business valuation method is EV (Enterprise Value). The model translates to “total business value”. EV is the sum of what a company is worth to all investors, i.e. to both shareholders and lenders. It can be considered the theoretical price to buy the entire business, that is, the price to buy all the shares and pay off the company’s loans.
This includes the company’s market value plus the company’s net debt. Thus, EV = market value of shares + market value of liabilities – cash. EV is the value that the company’s future cash flows must meet for today’s market value to hold.
Many transactions are often done on a debt-free basis so two common metrics are EV/EBIT and EV/EBITDA. The reason for using profit before interest payments and tax is that liabilities are included in EV, which makes the measure comparable across most industries. EBITDA should be used primarily when it is believed that depreciation and write-downs do not give an accurate picture of the company’s investments.
EV/S is a number that is often only used when a company is in a development phase and is not yet profitable. The company’s ‘enterprise value’ divided by the company’s turnover can be calculated regardless of how loss-generating the company is.
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What is the difference between a company´s market value and the valuation of a company?
Market value can most simply be described as the price a buyer is willing to pay and the price a seller is willing to sell their business for. In practice, several different factors come together to determine the price. These include the number of interested buyers, the importance of the urgency of the agreement, and the negotiating position of the parties involved.
The starting point is that both value and price will fluctuate during a company’s lifetime and perhaps especially in a negotiation. The fundamental value of a company is primarily based on your and the buyer’s belief about the future as well as the buyer’s trust in the company. Do you believe in the company’s ability to grow and become profitable? It also depends on the industry the company operates in, is it a cyclically sensitive industry or not? The price is also affected by other things such as the timing of a sale, timing is often an important factor.
Is there perhaps a peak in interest in the company for a limited time? This can affect the price of the company. To evaluate the price and decide on your investment willingness, you must weigh all factors and establish a connection between the company’s fundamental value, accounting information and the future prospects of the company. Based on that, buyers and sellers can hopefully reach an agreement on the price.
There are some general principles when looking at the relationship between market value and fundamental value. When the fundamental value is greater than the market value, the market is for some reason undervalued compared to the actual value of the company. Many investors seek out these companies because they are seen as good investment opportunities. In the scenario where market value is greater than book value (that is, assets minus liabilities), the perception is that the company’s future returns will exceed the required return. When the market and fundamental value are equal, there is a consensus between the buyer and the company’s valuation.
What is important to consider before selling a company?
There are different strategies and models you can choose when it comes to valuing your business. There is a danger in having too high expectations about the future development of your company, especially if you are facing negotiations to sell your company.
A starting point when selling your business is to know the value sooner rather than later. Feeling confident in your assessment will help you decide how to pitch the business to potential investors or price the business correctly to find the right buyer.
Risks of having too high expectations about the future
Before a sale, painting unrealistic expectations about the company’s future can involve legal consequences. If the company’s historical results do not reflect the business, it can also incorrectly affect the valuation. In addition to legal action, it can lead to a bad reputation in the industry and overall distrust. Income and expenses must equal the cash flow in the long term. Any differences must be handled with accruals and adjustments to balance the income that has been earned (revenue), or any expenses that have been incurred but not yet recorded. These effects that occur at different times will be balanced out in the long run. Often, deviations in expectations about the company’s development are handled in specific clauses in contracts between buyers and sellers. In the clauses, you can link additional payments, so-called additional purchase prices, which are based on the company’s future results.
It is difficult to influence the value of the company before a sale in a short time. It is a process that must be started in good time. Limited actions close to a sale only have a marginal effect on the valuation. An important part of the company’s value in many knowledge companies is the intangible assets: knowledgeable employees, customers and business processes. Assets needed to maintain day-to-day operations and make money. Without doing a proper business valuation before a negotiation, you risk either starting from too high a price and scaring away potential buyers or starting from too low a price and risking being underpaid. Both situations are bad for a seller, but with an independent business valuation, your credibility increases because the buyer will be able to see how you arrived at your expected price.
How do you do a business valuation in a startup?
Most valuation models are based on historical revenue and earnings – something that is not available in a start-up business. A start-up business usually has no or low revenue. So how does one go about valuing a startup?
The basics of valuing a startup:
There are a few different factors to consider when valuing a startup. A couple of factors that will affect the valuation are expectations about the company’s future revenues and results, whether the company is a game changer in an existing market, competitive advantages and the founders’ previous experiences and successes as entrepreneurs. Factors that can lower the valuation can be low margins, high competition and management with limited experience. The question of valuation in a startup usually comes into play when founders want to bring in external capital.
What’s worth keeping in mind is that business owners generally want to value their business as high as possible, while investors are looking for the lowest possible valuation to maximize return on investment (ROI). One way to value startups is to combine several different models and find a reasonable average value. Since startups don’t normally have historical numbers to go by, the models are based on well-founded forecasts. The first useful model is the comparable transaction method. Find out how much similar companies in your industry and region are valued.
There are some important factors when valuing a startup:
1. Number of users – if there are customers in the early stage, it has a value.
2. Effective marketing strategy – if it can be demonstrated that the marketing methods attract valuable
customers at a relatively low acquisition cost, this also has significance for the valuation.
3. Growth – if the company can grow with a limited budget then it is positive as many investors will see the potential for growth with additional funding.
A functioning marketing strategy will lead to growth, which will mean that the number of users (customers) will increase. All in all, this shows that you have a functioning and scalable business model, which will have an impact on the value of the company.
When that happens, the number of users will rise. Therefore, by proving that you have a viable, scalable business idea, you automatically add value to your startup.
Other important factors:
A diversified and functioning management team
Some important characteristics of management:
Previous proven experience – if the team includes people who have previously successfully built other startups, this will matter in the valuation of the company.
Complementary competencies – it is optimal if a startup team has a mix of experts whose competencies complement each other. A qualified programmer working together with a marketing expert is an example of competence in the founding team that is valued by investors.
Commitment – good people must put in a lot of time and commitment to ensure that the company gets up and running quickly. A team of part-time employees is not attractive from an investor’s perspective.
A working prototype – Being able to show off a working prototype has great value for potential investors. Being able to show investors a working prototype of your product not only proves that you have the tenacity and ability to realize a business idea, but it also increases the likelihood of a near launch date.
Supply and demand – If your company operates in a highly competitive market with few potential investors, the company’s valuation will be affected. However, if you have a unique and patented idea that has attracted the attention of many investors, it will increase the value of your startup.
Current trends – Investors often move in herds in search of the next big hit. Some examples are SAAS companies and companies active in AI that attract investors who are often prepared to pay a premium. This means that your startup can be worth more if you operate in an industry that is in line with current trends.
High margins – A startup with high-profit margins and expected high revenue growth is attractive to investors and often generates higher valuations.
Common valuation models for startups – Several different valuation models are used specifically for startups: the Berkus method, the Scorecard model and the Venture Capital (VC) method. These are some examples and are described in more detail under “Valuation models”.
How do I increase the value of my company?
Make your business stand out. There are lots of different valuation models and most have both advantages and disadvantages when it comes to assessing a reasonable value for your company, but the basic idea is that all models should give the same value if the conditions put into the model are the same. Most models all have one thing in common: growth and profitability are the key factors for creating value in the company.
Regardless of whether the valuation model directly or indirectly focuses on growth and profitability as key factors, they always play a large role in the valuation process. Why? When your business consistently generates a higher rate of return than your investors demand, you create value that far exceeds the book value on your balance sheet. So how do you increase the value of your business? It’s an important question and we provide some answers below:
1. Recurring and predictable revenue.
2. A unique product or service that is difficult to replicate.
3. Growth, especially if it is above the industry average.
4. Satisfied customers.
These are a few examples, but worth noting is that all points are closely related to growth and profitability. We have mentioned before that the earlier you start following the value development in your company, the greater the opportunity you have to influence the company’s value before a future sale. It’s a good reason to do a business assessment annually to discover areas for improvement.
By, for example, increasing the repurchase frequency of your existing customers, costs will go down and productivity will increase. To see the results over time, you need to make several strategic decisions. While this list mentions valuable strategies, there are other steps you can take to increase the value of your business.
Some suggestions are to make scalability visible in the business, further develop areas that provide competitive advantages and raise the prices of your products and services. Keeping key people on board is also a good strategy because they provide stability and that invaluable knowledge stays in the company.
Understanding a business valuation
From a pure valuation perspective, the most important issues are recurring revenue, profitability and growth. It is quite logical that a buyer is willing to pay more if they see profits increasing, as it shows a more stable and profitable future. Be sure to align your actions with your value creation goals, and implement changes by assigning the tasks to the best-suited people in the company. These factors we have covered will help you build a stronger and more valuable business! The most important elements to improve value are:
1. Generate a return on equity that exceeds the required return.
2. Exceed expectations brought about by previous years.
3. Invest in growth only if the return is above the cost of capital, i.e. focus on profitability first and growth afterwards.
By doing continuous business valuations, you can easily follow the value development and see the effects of your work in making your company higher valued.
Here are some more tips:
Show good returns and low risk.
To reach an optimal value during a sale, it is always a matter of showing that the asset can generate a good return, but it is equally important to show low risk. Financially, it is of course an advantage if the company can show a strong financial history. Admittedly, a company’s value is the sum of future profits, but the probability of future development is strengthened by a stable and documented history.
Explain the historical development.
By explaining the historical development, it can be easier for potential buyers to understand the company. A restructuring of the company may have meant that loss-making parts of the business have been shut down and no longer harm the business’s cash flow. It is then important that potential investors understand which activities have been carried out and why the parts no longer exist and affect the business negatively. It is called presenting a “normalized” result, which is common.
At the same time, it is important to show what drives the company’s core profits. By having a well-thought-out history, you can also reduce the perceived risk in the company. It is important to have answers to questions about why a company should be sold, and why the owners should leave the company. In many cases, a change in ownership can improve a company’s performance and growth. The reason for a sale can be, for example, due to illness, that the owners do not have the opportunity to develop the company further or that the owners want to realize the accumulated values in the business.
Set strategy for owners and review the company’s customers and suppliers.
It is not uncommon for owners and management to be key people in the business. In addition to being owners, they can also sit on the board and hold important positions in the company. It can often be an advantage to make the company independent of the owners before a sale. This of course applies if the owners intend to cease being active in the company. In other cases, a value can be positively affected by the proposed new owner and the sellers working together for the foreseeable future to develop the company towards new goals. In these situations, the sellers often reinvest part of the purchase price and share in the future returns in a joint exit.
The dependence on the owners in the business is not limited to the owners, but more perspectives should be considered. What does it look like on the customer side? A potential buyer would prefer that the company is not overly dependent on individual large customers. It will of course hit the company hard if there is a risk of these disappearing, which affects the perceived risk negatively.
With a well-thought-out strategy through which management and owners invest time and effort in creating a good balance in the customer mix. The same applies to the supplier side. Here, too, it can be perceived as risky and value-reducing if the company is too dependent on one or a few suppliers.
Identify and describe the potential and possible additional acquisitions.
To substantiate the value by reducing the risk in the business, it is important to describe the potential correctly. The owners and management often have a good idea of what future development and growth areas exist for the company.
You should spend a lot of time and effort on calling in and analyzing what conditions the company has for growth in the future. For example, to expand the product portfolio or grow geographically. Often it is enough to show a proof of concept in establishing the company in a new geography or customer target group.
It is positive if the company can show that there are identified potential acquisitions. These may concern acquisition discussions that have begun, but which for various reasons have not been concluded. Extensive research on various target companies should be done before starting a discussion with a potential buyer.
What creates long-term value in a company?
The long-term value in your business is created by satisfied customers, suppliers who offer quality at the right price, investors who add value to the business and employees who are motivated and enjoy their work.
How does risk affect a business valuation?
The first sophisticated theories of financial risk were developed in the 1950s, and although they have been revised and developed since then, there is no universal truth regarding risk. The definition of risk will vary depending on who is responsible for the risk. Buyers, sellers, investors and customers will all have their definition of risk, as well as varying levels of risk aversion. The general definition of risk is the uncertainty of what lies ahead. Above all, the future itself involves a risk because there are so many variable factors that determine the outcome of a situation.
If we look at a business activity, the risk is often associated with the investment, and more specifically return on investment. An uncertain financial outcome means risk in a company. Will the actual return on investment differ from the expected return? This is an important distinction because risk and volatility are not the same things. An unstable or volatile company does not automatically mean that it is risky. If you can predict the company’s cash flow or profit, you can plan accordingly and make the necessary preparations. In most investment situations, the risk is the uncertainty perceived by the investor.
A deeper understanding of risk.
To deepen our understanding of risk, we need to examine various factors that influence risk. First, we have industry-specific risks. In general, most companies in the same industry have similar risks. It can be based on day-to-day activities such as a company’s geographic location or the equipment used, but the risk can also come from the overall growth prospects of the industry.
These risks include barriers to entry, consolidation trends and technological requirements. Then there is the underlying risk to the business itself. In this case, we look at varying supply and demand for different cost structures that affect the company’s performance and size of the company. Larger companies tend to be more stable than smaller companies with a niche customer segment. Some companies are loan-financed, which affects the risk in the companies.
Usually, companies that rely on debt financing involve higher risk for the shareholder – all else being equal. Assets are often used as collateral, exposing the investor even more to risk.
Cash is king.
Investors are also sensitive to liquidity issues. Will the investor be able to sell his holding at a given time? If not, it may be difficult for the investor to get rid of their money when needed. A good example is the property market. Sometimes it can be difficult to sell real estate at any given time depending on market conditions, compared to, say, government securities. From an investor’s perspective, it is a great advantage if an investment in a company can be realized quickly.
No universal truth.
There is no simple answer to the question of what risk is because it differs in many different situations. But by breaking down the concept of risk in different investor situations, we can gain some insight. A general principle, which we argue is safe to adopt, is that as an investor, the more risk you are exposed to, the lower the value of the company.
By thoroughly doing your homework on the logic of the company and thereby enabling an estimation of your company’s value, your risk assessment has a much greater chance of accurately reflecting reality. By doing so, you get one step closer to a reasonable idea of what your specific risk is and you can act on it!
What does a business valuation mean for a small business?
By knowing your company’s value today, you can influence your company’s value tomorrow. A common misconception among entrepreneurs is the idea that you only need to know the value of your business when you’re ready to sell. But ask yourself the following: Do you own all or part of the company? When do you want to retire? Are you planning to grow?
If you answered yes to any of these questions, there are benefits to knowing the value of your business today. In many cases, entrepreneurs realize too late the importance of valuing their business. This is particularly common among SMEs. The impression that a valuation is complex, costly and very time-consuming are some of the reasons why entrepreneurs tend to wait to value their companies. If you start too late with the valuation question, there is little or no chance of increasing the value of your business before a sale.
Where are you now and where are you heading?
A business valuation gives you a fairly solid idea of how your company is performing today, but also an insight into where you are going. Knowing which areas need improvement to increase value is an extremely valuable part of a business valuation. Since many business owners first do a business valuation before a sale, there is little or no room to improve the results.
A valuation of your company can show which areas need improvement and can thus serve as the basis for strategic decisions aimed at developing and improving your business. There are various scenarios where a valuation is of great importance. Putting aside personal issues like divorce and retirement, there are several business situations where a valuation is necessary. If your company is large enough, a listing on a stock exchange may be an option, which means that it is of the utmost importance to set a price that the market considers fair and thus accepts.
Do you want a good price when you sell your business? An independent business valuation can be a good starting point in a negotiation for a sale of the company. By valuing the company annually before a sale process and taking measures, the value can be improved and thus the price level in the event of a sale. It is also worth mentioning that a business valuation is an incredible help during negotiations, but it does not replace the negotiations themselves. If you value your business, you should know the value of your business!