How UK businesses are valued

Almost every owner-managed UK business is valued the same way: take the profit, adjust it to show what a new owner would actually earn, and multiply it by a number.

The arithmetic takes ten seconds. The two inputs take considerably longer, and the multiple in particular is where most of the misunderstanding lives.

Step one: adjusted profit

The profit in your statutory accounts is not the figure a buyer values. It is the figure your accountant arrived at after legitimate decisions about salary, pension, capital allowances and anything else which reduced the tax bill. A buyer wants to know what the business earns as an economic unit.

So the profit is adjusted. Add back:

• The owner's remuneration above a market rate for the work actually done
• Genuinely personal costs run through the business
• One off items: a legal dispute, a rebrand, an office move
• Non-trading costs, such as a property held in the company for the owner's benefit

And sometimes deduct: a cost the business has not been paying but a new owner will, such as a market rent where the owner owns the freehold personally and charges nothing, or a manager's salary where the owner works unpaid.

Adjustments that survive a buyer's accountant are documented, evidenced and genuinely non-recurring. Those that do not are covered in our guide to add-backs.

Step two: the multiple

Here is the part that is widely misunderstood. The multiple is not a sector constant. It is a measure of risk and transferability.

A buyer paying three times adjusted profit is saying, roughly, that they expect to get their money back in three years and that they are confident enough in the earnings to accept that timescale. A buyer paying six times is saying they are considerably more confident, or that they can do something with the business that you cannot.

What moves the multiple up:

• Recurring or contracted revenue. A maintenance contract renewing annually is worth more than the same profit earned from one off jobs.
• A management team. The business runs without the owner. This is the single largest factor for most small businesses.
• Customer diversity. No customer over 10 per cent beats one customer at 40 per cent, at the same profit.
• Growth, evidenced. Three years of growth is worth more than three flat years, and considerably more than three declining ones.
• Barriers to entry. A licence, an accreditation, a long-held approval, a genuine brand.
• Clean records. Not a value driver exactly, but poor records reliably reduce the multiple because they increase perceived risk.

What moves it down: owner dependence, concentration, declining revenue, a short lease, a regulated activity with a poor rating, customer contracts terminable at short notice, and any material uncertainty a buyer cannot resolve.

Why two identical businesses are worth different amounts

Take two businesses. Both turn over £1.2 million. Both produce £250,000 of adjusted profit. Both are in the same sector.

Business A. The owner quotes every job, holds every key customer relationship, and works six days a week. Two customers are 55 per cent of revenue between them. The lease has three years to run.

Business B. A manager runs the operation and has done for four years. The largest customer is 8 per cent of revenue. Sixty per cent of revenue is on annual contracts that have renewed consistently. The lease has eleven years and a tenant-only break.

Same profit. Business A might attract two and a half times adjusted profit if it finds a buyer prepared to take on the job. Business B could reasonably attract twice that, because the buyer is acquiring earnings rather than employment.

The difference is not the accounts. It is what happens to the accounts when the owner leaves.

The methods, and when each one is used

Multiple of adjusted profit

The default for profitable owner-managed businesses, and what the rest of this article assumes.

Asset based

Used where the assets are worth more than the earnings justify: property-heavy businesses, or businesses that are barely profitable. The value is the net realisable value of the assets, sometimes with a modest premium for the trade. If a business is worth more broken up than running, this is the number that matters.

Revenue multiple

Used where profit is deliberately suppressed for growth, most often in online and software businesses. It is a riskier basis for both sides because it assumes a margin that has not yet been demonstrated.

Discounted cash flow

Projects future cash flows and discounts them to a present value. Intellectually the most rigorous method and rarely the operative one for a small business, because it requires forecasts nobody can rely on. It is more common in larger transactions and in professional valuations for tax or dispute purposes.

Comparable transactions

What similar businesses actually sold for. The best evidence there is, and the hardest to obtain: private company sale prices are not public, and the published indices tend to cover a larger size band than most owner-managed businesses occupy.

What the price is not

It is not the asking price. Asking prices are a marketing position.

It is not the valuation your accountant did for probate or a share transfer. Those are prepared on a different basis, often with a minority discount, for a different purpose.

It is not the total consideration until you read the structure. A headline of £900,000 with £300,000 deferred over three years and conditional on retaining two customers is not £900,000. See our walkthrough of heads of terms.

It is not what you need. The amount required to fund your retirement has no bearing on what the business is worth. This sounds obvious and is the most common reason owners reject reasonable offers.

What is added, and what is not

Two adjustments frequently get muddled.

Freehold property is added, not multiplied. If the business owns its premises, the trading value is calculated on the profit and the property value is added on top. Multiplying a profit that is already higher because no rent is being paid, and then adding the property, counts the same benefit twice.

Stock and work in progress are usually additional, particularly in retail and trade businesses, and usually at valuation on the day rather than a book figure.

Cash and debt normally come out. Most deals are agreed cash free and debt free: the business is handed over with neither, and the completion accounts settle the difference.

A worked example

A trade services business. Turnover £860,000. Statutory profit £96,000.

| Line | Amount | | --- | --- | | Profit per accounts | £96,000 | | Add back: owner salary and pension | £74,000 | | Add back: owner's vehicle and personal costs | £11,000 | | Add back: one off tribunal costs | £9,000 | | Deduct: market rate manager to replace the owner | (£48,000) | | Adjusted EBITDA | £142,000 |

At 2.5 times, £355,000. At 4 times, £568,000. That spread of £213,000 is not a rounding difference: it is the entire negotiation, and it is decided by whether the business can be shown to run without the person selling it.

Our valuation calculator will give you a range on this basis. It is arithmetic rather than a view, and it says so.

What to do with all this

If you are selling soon, get the adjusted profit right and evidence it. That is the input you control and it is worth more attention than the multiple.

If you are selling in two years, work on the multiple instead. Reduce the owner dependence, diversify the customer base, convert what you can to recurring revenue, and sort the lease. Those four things will move the outcome considerably more than negotiating hard on the day.