Business Value Guide

The right mindset

A company valuation is not a science, but the telling of a story

Calculating the value of a company is not a science and is not objective. Apparently neutral numbers, “hard facts” are used and calculations are made based on academic models. However, these are based on assumptions about an uncertain future. The individual valuation methods give you the necessary tools to quantify your assumptions and opinions in a consistent manner. However, there is always a subjective story behind it, influenced by the author of the review.

The valuation will reflect what one already believes about the company

Most people who are concerned with valuing a company already have an idea of what they think a company is worth. This preconceived opinion will find its way into the evaluation. Be it through the choice of valuation method, the assumptions for future growth or the selection of companies with which comparisons are made. The valuation will reflect what the creator already believes about the company. Therefore, be aware of your own biases and when looking at a company review, always ask: Who created this review or paid for it and what biases and motives are involved in it?

More complicated does not mean better

Beware of false accuracy when calculating company value! The more complicated a valuation model, the more ways the author will find, consciously or unconsciously, to reflect his bias in the valuation. Anyone who cannot easily explain their company valuation to someone else has not understood it themselves.

Think in bandwidths and scenarios

Whenever possible, use at least two methods of business valuation and look at the business value from multiple angles . Try to understand why different valuation methods produce different results. Investigate how changing assumptions and forecasts changes the valuation results. This will give you a feel for the possible range of company value and what it depends on.

The most common valuation methods in brief

Please also read our more detailed overview of the common valuation methods .

Multiplier method

Current prices from comparable companies are used for the valuation. The sales price is viewed as a multiple (“multiple”) of a basic key figure, such as EBIT, EBITDA or sales.

Purchase prices of small and medium-sized companies are rarely published. A comparison with listed companies is useless, since smaller companies usually command much lower multiples. Every month, NIMBO publishes the currently observed EBIT, EBITDA, EBITC and sales multiples for different countries, company sizes and industries. Please also read the detailed explanation of the individual multiples .

Simplified income approach

The formula for this valuation method is: Enterprise value = earnings divided by capitalization rate. The capitalization rate shows that these returns are in the future and are subject to risk. The level of this assumed interest rate is subjective. For smaller companies it is in the range of 10-20%. Small changes in the interest rate have a big impact on the calculated company value. This earnings value method is called “simple” because it only assumes an adjusted sustainable profit. There is no detailed information on future earnings trends. Of course, only profitable companies lead to positive ratings. Evaluating unprofitable companies using this method is pointless.

Discounted Cash Flow Method (DCF): The flexible earnings value method

This valuation method is closely related to the simple income approach described above. The interest rate is applied individually to the future cash flows ("free cash flows") for the next 5 years. For the time thereafter, the so-called residual value is added. This is very similar to the simple yield value described above. The sum of these discounted cash flows and the residual value of the company results in the enterprise value. This valuation method is very flexible and, from a theoretical point of view, "best practice". However, it is even more subjective and sensitive than the income approach. Never trust a DCF valuation that you have not whitewashed yourself. Here you can find more information about the discounted cash flow method .

Net asset value method: Calculating company value as the sum of assets

The intrinsic value is obtained by first adding the values of fixed assets and current assets at market prices. These include balance sheet items of a material and intangible nature. Taxes, debts and liabilities are deducted. Hidden reserves are dissolved. What is objectively present is therefore soberly assessed. However, a buyer is usually not only interested in the substance of the company. He wants to know what profit can be generated with this substance in the future. Therefore, this valuation method is only used in combination with other methods. If the selling price is lower than the asset value, it would make sense for the entrepreneur to simply liquidate the company. Therefore, the intrinsic value serves as a lower limit for the company’s value. The net asset value method is also used when other methods lead to negative valuations.

Method mix and mean value methods

The individual methods have strengths and weaknesses. It is therefore advisable not to rely on just one method. A mix of different methods, played through several times with varying scenarios, gives a feeling for the possible range of the company’s value. The averaging methods often involve taking a weighted average of the simplified earnings value and the intrinsic value. These include, for example, the Berlin method , the Vienna method , the excess profit method and the Swiss or practitioner method . The so-called Stuttgart procedure was abolished in 2009.

Assessment standards

Court-proof standards have been established for inheritance and family law disputes.

IDW S1 procedure

In Germany, the IDW S1 procedure was developed by the Institute of Public Auditors (IDW). It defines basic concepts on how individual valuation methods are to be applied. In most cases, the defined principles are applied to the income approach. But they can also be transferred to other methods. The IDW S1 method differs from the simplified earnings value method in many respects and is more complicated to apply. For example, a budget forecast for the next three years is required and the discount factor must be calculated individually from several factors.

The AWH procedure for the valuation of handicraft companies

This procedure was developed by the working group of value-assessing consultants in the trades. It is based on the earnings value method. The basic principles are closely based on the IDW S1 procedure. These will be adapted if they are difficult to implement for small and medium-sized craft businesses.

The top factors for company value

Supply & Demand

There is no objective company value if you want to sell a company. When a company is sold, supply and demand determine its value.

Financial indicators

Companies are valued based on their expected future returns. An analysis of past and current returns provides information about possible future developments. The returns are checked for sustainability. Extraordinary gains and losses are excluded. In which direction is the trend of sales and returns pointing? Can bad years be explained?

Trust in the seller and his documents

The greater the risks, the lower the company’s value. There must be no doubt about the accuracy and completeness of the information. This unnecessarily increases uncertainty on the buyer’s side. It is important to prepare all documents accordingly. These should provide a transparent and error-free picture of the company. Nasty surprises must be avoided at all costs.

Dependence of the company on the owner

For an investor, a high level of dependence on the owner is a risk. How will the company continue to operate if the current owner is no longer there? What if you can no longer rely on your experience, knowledge and relationships with customers and suppliers?

Market position of the company

How replaceable is the company for its customers? Is an interesting niche being occupied? Are there sustainable competitive advantages? A clear focus, an excellent reputation and long-standing customer relationships are difficult to copy.

Risks

A balanced customer base, replaceable business partners and low dependence on individual employees reduce the risk.

Growth prospects

Is the business model geared towards growth? What are the chances for a potential buyer? Are there attractive economies of scale?

staff

How high is the employee turnover? What is the sickness rate? What is the age structure? How sought after are employees on the job market?

Avoid these 5 common mistakes

Bias

Business owners understandably find it difficult to look at their own company objectively. Price expectations are often too high. So ask yourself: Would you buy the company yourself at this price? Couldn’t you start a new company with that amount? How long would it take for a buyer to refinance the sale price in profits? Tip: Nobody wants to be in the red eight years after buying the company.

No market wage for the owner

A profit is only really a profit if all employees – and that includes the managing director! – were paid at market rates. Anything else is a distortion of the earnings situation, which leads to an overly high valuation.

Orientation towards large companies

The market leader in your industry is valued at three times its sales? Amazon was already worth billions before it even made a profit. The EBIT multiples of listed companies are often double-digit. However, for companies with sales of less than 20 million, EBIT or EBITDA multiples between 3-6 are the norm. In our overview you will find realistic valuation multiples for a company of your size and your industry . Is your company the rare exception? Then you will notice this through regular, unsolicited and concrete purchase offers.

“Full warehouse” and “expensive machinery”

Most valuation methods are based on the company’s earnings. The company is seen as an instrument for generating future profits. Everything needed to generate these profits in the future has already been taken into account. These include machinery, warehouses, innovative products, etc. If these things do not lead to higher profits in the future, they are worthless from this perspective. However, many owners would like to add the inventory to the company’s earnings value, for example. This is not appropriate with these methods. (Thoughts on the valuation of inventory when selling a company)

“The company has a lot of potential”

Almost every company still has “a lot of potential”. Capitalizing on this requires a great deal of entrepreneurial spirit and resources and should therefore only be factored into the valuation cautiously. Anyone who wants to exploit the full potential of the company should do this themselves and only sell the company later. Nobody believes a salesperson that the company is about to make a big profit. Why would he want to sell at this exact time?

The process of a company valuation

1) Cleanup of accounting records: The annual financial statements of the last 3-5 years are normalized. Extraordinary expenses and income, non-operating expenses, hidden reserves and tax optimizations are deducted. Entanglements with the owner’s private life are resolved. If necessary, salaries of the owner or other related persons that are not in line with the market will be adjusted. The resulting financial figures should reflect as accurately as possible the company’s sustainable earnings position, which is also realistic under new ownership.

2) Create budget figures for the next 3-5 years (preferably for different scenarios).

3) Valuation using the various popular valuation methods, taking into account the previous points.

4) Mix of the individual methods for calculating averages and ranges, also taking into account different scenarios and assumptions.

If it need to get fast

Calculate company value rule of thumb

You just want an indication of the company value of a small or medium-sized company based on a rough company valuation formula?

• Calculate company value Rule of thumb 1: Calculate the average of the EBIT (earnings before interest and taxes) of the last three years. Multiply this by a factor of 4 (low value) to 6 (high value). Subtract the company’s debts from the results. You will receive a range within which your company’s value roughly falls.

• Calculating company value Rule of thumb 2: Consider how much profit a buyer could take out of the company in the next few years. Set the price so that the purchase price can be recouped within 4 to 7 years.

You can find an overview of common rules of thumb in our blog post on the topic.

Calculate the value of a company with online services

An online company valuation can provide a good first indication of a possible sales price. However, a specialist expert should always be consulted for a definitive price determination.

Characteristics of a good online company review

• Systematic guidance through a structured questionnaire
• Understandable for laypeople
• Financial figures can be adjusted
• Calculation of company value based on current market data
• Considers different industries
• Takes different company sizes into account (a company with 5 employees is valued differently than one with 50 employees)

Online company reviews are NOT suitable…

• … for the evaluation of startups
• … to calculate the value of a company that is growing very quickly
• … calculate the value of a company if it is making a loss or very little profit (check out our tips for valuing unprofitable companies )

Beware of marketing tricks!

Many online calculators have only one goal: to generate leads for company sales. They suggest that you will receive an automatic evaluation after completing the questionnaire. At the end comes the surprise: You have to enter your contact details and a “technical expert” (salesperson) will contact you.

How to choose the right valuation method

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Not every valuation method is suitable for all companies. The figure below shows a decision tree that will help you to choose the right valuation method. If possible, use multiple valuation methods to obtain a range of possible company values.

The multiple method and the simplified earnings method are suitable for stable and profitable companies. Their advantage is that they are simpler and easier to understand (e.g. compared to the discounted cash flow method), require fewer assumptions and do not require a detailed profit forecast for future years. They are based on the current situation of the company. However, they cannot take future developments into account.

The discounted cash flow method (DCF) is very flexible and can basically be applied in any situation. However, the method is based on many assumptions and forecasts must be made for several years. Small changes can mean big fluctuations in the evaluation result. The evaluation model can also give the impression of accuracy. In stable companies, the method can at best be used as a supplement to simpler methods.

The net asset value method only considers the current assets of a company. For a profitable company, the intrinsic value is significantly lower than the valuation result from other methods. If this were not the case, it would mean that selling the company’s individual assets (and thus dissolving the company) would make sense. The advantage of the asset value method is that it is comparatively simple and "objective". The intrinsic value can be seen as the lower limit of the company’s value. In certain countries, the tax authorities’ valuation is based at least in part on this valuation method.

The venture capital method is widely used in practice to evaluate startups. It is an adaptation of the discounted cash flow method.

Industry-specific features

The basic assessment is more or less identical for all companies, but depending on the industry there are special features that need to be taken into account. Does your company belong to one of the following industries? Then take a look at our blog posts that deal with the special features of evaluating companies in these industries.

• software company

Relevant value drivers in this industry are: switching costs for the customer to another provider, marginal profit and contractually recurring sales.

• manufacturing company

Relevant value drivers in this industry are: intellectual property rights to the products, large-scale production, a standardized product range, a high proportion of self-created value creation and the age of the machinery.

• Online shop

Relevant value drivers in this industry are: sales channels, the share of private labels, the organic share of new customer acquisition and the customer loyalty and repeat purchase rate.

• Wholesale

Relevant value drivers in this industry are: the supplier structure, the level of the trading margin, the speed of inventory turnover, the proportion of own brands and the exclusive rights to the products.

Maximize company value before sale

There are a number of things that can be done before the sale to reduce uncertainty and highlight the company’s strengths. This maximizes selling price.

Distribute knowledge, document processes, define deputies

This can minimize the potential damage if an important employee is absent or leaves the company. This reduces a major concern for a potential buyer.

Ensuring customer and supplier relationships

A buyer will be concerned about losing important customer or supplier relationships after the owner leaves.

• Transfer important relationships to employees who are likely to stay with the company.
• If possible, secure customer relationships through service agreements and loyalty programs.
• Identifying alternatives for key suppliers to mitigate the risk of failures and price increases.

Optimization of receivables management

Reduce the capital tied up in current assets. This will directly increase your company’s value. Shorter payment terms for customers and a consistent dunning system should be examined.

Prepare annual balance sheets

The annual financial statements for the last 5 years must be prepared in a transparent and easily understandable manner. Fluctuations in sales, drops in profits, noticeable jumps in costs, etc. must be able to be explained plausibly upon request. This creates trust and increases planning security.

Document well-known references

Get references from reputable and satisfied customers and include them in your sales documents.

Convincing formulation of market advantages

What makes the products or services unique in the market? What is difficult for the competition to copy? Focus on what’s important and get to the point. Include the stated benefits in the sales materials.

Create a plausible growth plan

Identify realistic and concrete potential for further growth and efficiency improvements and show concretely how these can be realized. Also, be prepared for the question of why you haven’t implemented them yourself yet.

Anticipate and prepare for the buyer’s further information needs

The greater the buyer’s uncertainties and doubts, the lower the purchase price. Build trust with well-documented, clear, complete answers to anticipated questions.

Clarify unregulated employee claims

Clarify and document all claims for bonuses, vacation, promised pay increases, etc. Negative surprises for the seller must be avoided.

Secure business premises

Increase planning security by securing long-term rental agreements for your premises, if necessary by renegotiating with the landlord.

Resolve internal conflicts

Arguments should be resolved and bad moods in the team should be improved. The sales process and the transition phase are challenging and the owner relies on the support of his employees.

Prepare business premises

The eye rates:

• Cleaning of the premises
• Carrying out necessary renovations
• Ensure compliance with legal requirements
• Sale or disposal of redundant machinery and inventory
• Clearing the warehouse

Update the company website

Avoid an outdated or unprofessional website.

Valuation depending on growth phase

Evaluate startups

Evaluating startups is even more subjective than evaluating established companies. One only evaluates a promise for the future. We have compiled a list of criteria for evaluation.

Important terms: Pre-Money vs Post-Money Valuation

When a startup closes a financing round, money flows into the startup’s bank account. The value of the company therefore increases by this amount of money. It is therefore important that it is clear when valuing whether you are talking about a “pre-money” valuation (value before the financing round) or a “post-money” valuation (value after the financing round).

Investors’ expected return on startups

Startups are risky investments. That is why investors expect a high return. The earlier the financing phase, the greater the risk and therefore the expected return. The expected return is needed for the DCF and VC methods.

Financing phase	Expected return / discount rate	Expected payback in 5 years
1 Seed Stage (foundation)	70-90%	20x
2 Start-up Stage (before market launch)	50-70%	10x
3 First Stage (Successful market entry)	40-60%	8x
4 Second Stage (Expansion)	35-50%	6x
5 Later Stage (positive cash flow)	30-40%	5x

Source: Venture Valuation, Lecture_IF-Company Valuation_2012.pdf, Slide 29

Discounted Cashflow Method for Startups (DCF)

The DCF method described above can be applied to business plans of startups. The discount rate used is derived from the investors’ expected return (see table above).

Venture Capital Method (VC Method)

This method is simpler than the DCF method. You use the simple multiplier method . This is actually only suitable for established, profitable companies. If the company is not yet making a profit, there is nothing to multiply. That’s why the first step is to imagine that everything goes exactly as described in the business plan. The multiplier method is then applied to the projected figures in, for example, 5 years. This will give the desired value in 5 years. Whether this scenario will actually happen is, of course, very uncertain. The future value is therefore calculated back into the present using the investors’ return expectations (see table above).

Example: A startup (first stage) expects the exit in 5 years. The expected profit in 5 years is 1 million. According to the multiplier method, the company would then be worth 6 million. Investors expect an annual return of 40%. The value of the company must therefore increase by 40% every year. The calculation has to be done using the following formula: 6.0 million / (1 + 40%) ^ 5 = 1.1 million. The company therefore receives a post-money valuation of 1.1 million.

Glossary: Important terms in company valuation

DCF

Stands for “Discounted Cash Flow”. The DCF method is a frequently used valuation method.

Derivative business value

Derivative business value is the difference between the actual purchase price of a company and its intrinsic value. The value is reflected in the accounting of a company that has purchased another company. From an accounting point of view, it corresponds to “goodwill” and “business value”. If the value does not come about through a purchase price, but is estimated, one speaks of “original business value”.

Enterprise Value

The total value of the company from the perspective of equity and debt providers. In contrast to the equity value, debt is not deducted. The value allows a comparison between companies with different capital structures.

EquityValue

The value from the perspective of equity investors. The equity value equals the enterprise value minus debt plus cash reserves.

Business value

In practice, this value is often equated with the total value of the company. From an accounting point of view, “business value” only refers to the part that goes beyond the net asset value (see “net asset value”) in the event of a sale. Equivalent to “goodwill” and “derivative business value”.

Goodwill

See “Derivative business value”.

Intangible assets

Intangible assets are assets that are listed on a company’s balance sheet but are not physically tangible. These include, for example, patents, trademarks and licenses. The sum represents the intangible value of the company.

Material value

Physically tangible assets such as machinery and inventory.

original business value

The original business value is the difference between the self-estimated total business value and the asset value. It cannot be reflected in the accounting records. In contrast to derivative business value, the value is not derived from an actual sales price but is an estimate. It may therefore not be included in the balance sheet.

Pre-Money Valuation

Refers to the value of a start-up before raising an additional round of financing.

Post-Money Valuation

Refers to the value of a start-up after new money has flowed into the company.

Intrinsic value

See net asset value method .

Frequently asked questions