When it comes to buying a business, one of the most important things to get right is offering a fair market price. Here are five considerations for valuing a business you intend to buy:

1 - Determining The Price

If you set about understanding business valuation theory using resources available to you on the internet, you will quickly find yourself trying to understand ‘present value cash flows’ and ‘weighted average cost of capital’ as well as other abstract areas of the capital asset pricing model.

The good news is that for a sale of a private business, most of this is largely irrelevant because they are bought and sold on a multiple of earnings that is based on comparable transactions. These are, in theory, valued using the capital asset pricing model, although adjustments need to be made for scale, liquidity and general market conditions. Such comparable transactions provide comfort to buyer and seller that a business with similar characteristics was sold on a similar metric.

This market analysis seeks to offer a range of multiples that can be applied to the Ebit (Earnings Before Interest and Tax) or Ebitda (Earnings Before Interest, Tax, Depreciation and Amortisation) of your target business. The correct earnings number to choose depends on depends on how much capital expenditure the business needs.

In addition, adjustments are made to account for excess cash balances (add to value) or debt (deduct from value), and normalised working capital. These are areas you should not overlook as they can contribute, or detract, materially from the net amount you pay.

2 - The Sector

One quick bit of research is to look at the relevant trade press (such Insider Media or Business Leader) as for details of other deals that have been done in the sector and how much businesses have been sold for.  Quite often, however, for small non-publicly listed companies you may not see the trade price published. This may be due to commercial sensitivities and clauses are often inserted into the deal contract to omit mention of value. Nevertheless, you can usually have to look at larger deals in your target sector and apply an appropriate discount factor. Note, however, that it’s not as simple as saying “company X is ten times bigger than mine, so I’ll get a tenth of that price”!

3 - Intangible Assets

Intangible assets such as trademarks, the company’s brand, and customer loyalty are tricky to place a value on. Therefore, when it comes to a sales process, they are not likely to have a specific value attributed to them. Nevertheless, if your target has a strong brand and good customer loyalty you should expect to pay a higher multiple.

4 - Growth

When looking at the target’s projected growth it is important to consider whether it is being acquired in order to take you in an interesting new direction and open new doors. In this instance projected short-term growth may be fairly meagre. If, however, you are looking for a bolt-on to your current offering then it is vital you ensure that it is that already enjoying solid growth.

5 - Making The Offer

When considering your offer you need two numbers in mind: what you want to pay and what you are willing to pay. It also important that your offer and the accompanying letter – which will usually extend to several pages – sets out matters from the seller’s perspective such as whether they will remain in the business, whether they expect all their cash up front, whether they want to leave a legacy (and if so, what your specific intentions are for your acquisition). In doing so, your offer is more likely to be complete and it will be better received.

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