Company valuations: Key considerations and methodology

Valuing trading companies is often a complex and nuanced process. While standard valuation principles can be applied, it remains a largely subjective exercise. Two professionals may interpret the same set of data and, based on their assumptions and analysis of key variables, arrive at differing conclusions.

Nonetheless, a consistent and robust methodology should always be applied when undertaking a valuation. Below is a summary of the core elements that typically guide this process.

Normalised profitability

The starting point for any valuation is a detailed review of the company’s trading history. Profitability is a primary driver of business value, and identifying the normalised level of profit is essential. This involves a thorough analysis of the P&L to adjust for any one-off, exceptional, or non-recurring items that may distort profitability in any particular year.

While most traditional businesses are valued based on profitability, certain sectors such as software and technology are often valued on revenue. In these industries, strong recurring revenue streams and scalable operating models mean future profitability may grow exponentially once a core platform is established.

Trading multiple

Once normalised profitability has been established, a trading multiple is applied to determine the enterprise value of the business (i.e. the value before considering the balance sheet).

Selecting an appropriate multiple is inherently subjective but must be supported by relevant market data and recent comparable transactions. Access to reliable data sources is critical in justifying the chosen multiple.

Several factors influence the multiple applied, including:

• Business size and scale
• Nature and strength of customer relationships
• Customer concentration
• Market opportunity and sector-specific dynamics
• The competitive landscape

Balance sheet adjustments

Valuations are typically calculated on a “cash-free, debt-free” basis, with a normalised level of working capital retained within the business to support ongoing operations. Accordingly, adjustments are made to the enterprise value to reflect:

• Surplus or deficit cash
• Outstanding debt or liabilities
• Working capital positions relative to normal operating levels

These adjustments result in the equity value, representing the value of the entire shareholding in the business.

Minority shareholdings

In many instances, valuations are required for a partial ownership interest rather than the entire shareholding. In such cases, a minority discount should be considered to reflect the lesser degree of control and the potential difficulty in monetising a partial shareholding.

The extent of the discount will depend on the size of the shareholding, with smaller interests attracting higher discounts.

Valuations are conducted for various reasons, including corporate restructures, shareholder disputes, investment decisions, or as part of preparations for a potential sale. Whatever the reason, it is essential that a professional methodology is followed, supported by comprehensive financial analysis and credible market data.

A well-documented, defensible approach enhances the reliability of the valuation and ensures stakeholders can make informed decisions based on sound financial insight. At Crowe, our corporate finance team has deep experience in helping SME owners through every stage of the business sale process, from initial planning to deal closure and beyond. If you're considering selling your business, get in touch with a member of our team. Let us help you make your next move the right one.