How to Value a Small Business for Sale

Starting your own business is an opportunity to take control of your destiny and make your mark. The UK is also among the most entrepreneurial countries in the world. According to one survey, the UK is fourth in the world and second among G7 countries for entrepreneurial economic impact. 

Suppose you’re thinking that now is the time to buy a small business for yourself. The most fundamental step in the process is knowing how to value a business. After all, the last thing you want to do is to overpay. 

In this guide, we’ll go through what valuing a small business looks like and how the process differs from valuing a larger company.

What affects the value of a small business?

Small businesses are the power behind the British economy. A recent government report found that SMEs accounted for 60% of UK employment and nearly half of all business turnover every year. 

But what is your small business for sale worth? If you’ve identified an opportunity, here’s the starting point for what actually influences the value of a small business: 

• Financial Performance – Revenue, sales growth, profit margins, cash flow, and projected earnings 
• Assets/Liabilities – Tangible assets like property and stock, intangible assets like intellectual property and reputation, and how much debt you’re carrying. 
• The Market – Industry trends, current economic climate, and the business’s market position. 
• Operations – Relationships with customers and suppliers, ability to scale, and the quality of the managerial structure and team in place. 
• External – Time in business and the circumstances behind the sale. For example, a forced sale, such as due to bankruptcy, will lower a business’s value.

Of course, the type of small business will change how much each factor influences the final result. For example, if you’re looking at an e-commerce business, tangible assets will be less important than intangible ones.

Valuing a small vs. a large business 

The UK’s small business community is relatively healthy, with median average revenues of £295,000 and average small business profits of £70,000 per year. You might think the valuation process is the same regardless of business size, but some key differences do exist, including: 

Data Availability – Small business valuations tend to rely on limited amounts of historical data, thus reducing the accuracy of the insights that can be drawn.

Valuation Methods – Bigger companies tend to rely on more sophisticated valuation methods not applicable to smaller companies, including Price-to-Earnings (P/E) ratios and Discounted Cash Flow (DCF).

Multipliers – Where multipliers are used, smaller companies will usually be assigned smaller ones due to the higher risk involved. For example, small firms may be assigned multipliers of 2-4 times pre-tax profits, whereas larger companies may receive anywhere from 6-10 times pre-tax profits.

Owner Dependence – The level of dependence is a big one in valuations because more dependence increases the risk for any potential buyer. Unsurprisingly, this is why valuations are higher amongst larger businesses because they tend to have multi-layered management teams in place.

Intangible Assets – The role of intangible assets in valuations can be immense. Typically, this is more of an issue for larger firms since they likely have a range of high-value intellectual property, a strong brand reputation, and a global reach.

Other differences in how firms of different sizes are valued, such as market influence, risk, and buyer type, which is why what works for a small eCommerce store won’t work if Sainsbury’s appears on the market.

Common business valuation methods for smaller businesses 

Smaller businesses will nearly always use more straightforward methods that rely on the data that’s already there. A valuation agent will also select the methodology that accounts for owner dependence and the inherent risks that come with working with a smaller firm. 

So, what does this look like? 

• Market-Based Multiples – The most common methods use market-based multiples, including EBITDA and Seller’s Discretionary Earnings (SDE), because these reflect the benefits of the owner-operator model. Of course, multiples are lower due to lower liquidity and the extra risk.
• Asset–Based Valuation – Small firms that are classified as “asset-heavy”, such as property or manufacturing firms, may use an asset-based valuation method. This is essentially a measurement of the value of your assets minus your liabilities.
• Market-Based Comparison – If there are sufficient recent sales, a valuation agent may compare a business to similar ones that have recently sold. It’s a less accurate option but will provide a quick estimate.

You may be wondering why other popular valuation methods, including DCF, aren’t used. The reason is simple. They hinge on the ability to make long-term forecasts, which simply isn’t practicable for most smaller firms because they’re less stable and their earnings are less predictable.

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Buying a small business: Understanding the sales valuation process 

Business valuation isn’t an exact science, which is why consulting a professional business valuation agent should be your first step once you’ve settled on a potential candidate for your next investment. 

But what does the process look like for valuing a small business, and then taking that valuation through to the actual sales stage?

1. Gather Information – Request detailed financial information as part of the due diligence process. This means getting financial statements, tax returns, and balance sheets from the last three to five years, asset lists, and key customer and supplier agreements.
2. Conduct an Analysis – Your valuation agent will then apply the valuation methods they feel most suitable. They may often select multiple methodologies to arrive at the most accurate figure.
3. Factor in the Non–Financial Side – Beyond the numbers, you’ll also look into aspects like industry risk, the broader economy, and future potential for that business.
4. Negotiation – Remember, the final valuation figure isn’t gospel. It’s your starting point for negotiation with the seller. Many entrepreneurs choose to bring in professional M&A consultants at this stage to avoid overpaying.
5. Decision Time – You don’t have to stick specifically to the figure given in your business valuation reports. Some entrepreneurs are willing to go higher if they spot considerable potential in a business. Likewise, if you’re unhappy for any reason, don’t be afraid to walk away from the deal and seek other options.

As you can see, the process of buying a small business for sale in the UK is pretty in-depth. Valuation is only a small part of it. Before you can think about valuations, though, you need to track down a shortlist of candidates that make a good match for you.

If you’re looking for the latest small businesses for sale in the UK, or you need help and advice on the sales process, contact Cogogo and speak to one of our experts today.