Factors Affecting Private Business Value

Understanding what determines the value of a private business is one of the most practically useful things a business owner can do, whether they are thinking about selling in the near term or simply want to know where they stand. Value in a privately owned business is not a fixed number. It is a range, and where within that range a specific business lands depends on a combination of factors that are well understood by experienced buyers and their advisers, even when they are not well understood by sellers.

This guide covers the main factors that affect the value of a private business in the UK, how each one is assessed in practice and what sellers can do to influence the outcome.

Maintainable profit is the starting point

Almost all private business valuations begin with maintainable profit. This is the profit the business generates under normal trading conditions, adjusted to reflect what it would earn under new ownership rather than under the current owner’s specific arrangements.

The adjustments made to arrive at this figure are significant and are routinely scrutinised by buyers and their advisers. Common adjustments include adding back the owner’s salary or drawings where they are above or below a market rate for the role, removing personal expenses that have been run through the business, stripping out one-off costs or income that do not reflect normal trading and identifying any costs that will change materially under new ownership.

The resulting figure, often expressed as EBITDA, is the foundation on which a multiple is applied to arrive at a valuation. Everything else that affects value either moves that EBITDA figure or moves the multiple applied to it, or both.

Sellers who do not have a clear and evidenced picture of their maintainable profit before going to market are at a disadvantage. The buyer’s advisers will produce their own normalisation, and if the seller cannot demonstrate and justify their own version, the buyer’s more conservative interpretation tends to prevail.

The earnings multiple and what moves it

The multiple applied to maintainable EBITDA varies significantly depending on the type of business, its growth profile, the quality of its earnings and a range of risk factors that buyers assess during due diligence. Understanding what moves the multiple up and what moves it down is as important as understanding the profit figure itself.

Factors that support a higher multiple include recurring revenue, where customers are contracted or habitual rather than transactional and the income stream is predictable. Businesses with a high proportion of recurring revenue are worth more than those where every sale has to be won from scratch, because the future earnings are more certain.

A diverse customer base supports a higher multiple because it reduces the risk that the loss of any single customer has a material impact on revenue. A business where the top five customers account for eighty percent of revenue is more fragile than one where no customer accounts for more than ten percent, and buyers price that fragility into their offer.

A management team that can run the business without the owner is a significant multiple driver. Buyers are acquiring a business, not a job. A business that requires the owner to be present every day to function is worth less than one with a capable management structure that gives a buyer genuine optionality about how involved they need to be.

Strong growth trends support higher multiples because they suggest that the future earnings of the business will be better than the current earnings used in the valuation. A business that has grown consistently over three years is a more attractive investment than one that has been flat or declining.

Clean, well-documented financial records support a higher multiple because they allow buyers to assess the business with confidence rather than having to apply a risk discount for uncertainty about what the numbers actually represent.

Owner dependency and its effect on value

Owner dependency deserves particular attention because it is the factor that most consistently reduces value in private business sales and the one that is most within the seller’s control to address before going to market.

A business that relies on the owner for customer relationships, technical expertise, supplier terms, day-to-day management or any other function that is not easily transferable is a business where a significant portion of the value walks out of the door when the owner leaves. Buyers understand this and they price it accordingly.

The practical test is straightforward: if the current owner stopped coming in the day after completion, what would happen to the business? If the honest answer is that it would continue to run well, the business has low owner dependency and the multiple reflects that. If the honest answer is that significant customer relationships would be at risk, key operational knowledge would be lost or the management would struggle without direction, the multiple will be lower and the buyer may seek a longer handover period, an earn-out structure or both.

Sellers who address owner dependency in the twelve to twenty-four months before going to market, by building management capability, documenting key processes and ensuring that customer relationships are held by the business rather than by the individual, are making a direct investment in their sale price.

Revenue quality and customer concentration

Not all revenue is worth the same. Buyers assess the quality of revenue as well as the quantity, and the characteristics of a business’s income stream have a significant effect on the multiple applied to its earnings.

Contracted or subscription revenue is the highest-quality revenue because it is predictable and does not need to be won repeatedly. Project or transactional revenue is lower quality because it depends on the business winning work in each period. A business with a high proportion of contracted or recurring revenue will attract a stronger multiple than one of similar size where most income is project-based.

Customer concentration is a related risk. Where a small number of customers account for a large proportion of revenue, the loss of any one of them would have a material impact on earnings. Buyers factor this into their assessment, and concentration in the top customers is a consistent source of lower multiples or price chip requests during due diligence.

The length of customer relationships is also relevant. Long-standing customers who have been with the business for many years are a more reliable indicator of future revenue than customers who joined recently, because they demonstrate that the business has the ability to retain relationships over time.

Growth prospects and market position

A business that operates in a growing market with a defensible position is worth more than one that is static or declining, even if their current earnings are identical. Buyers are acquiring a future income stream as much as a current one, and the trajectory of the market and the business within it affects what that future stream is likely to look like.

Market position matters because it affects the sustainability of the earnings. A business with a strong local or sector reputation, genuine competitive advantages or intellectual property that competitors cannot easily replicate is more defensible than one where the only advantage is price and any competitor could undercut it tomorrow.

Sellers should be prepared to articulate their market position clearly and honestly. A claim of market leadership needs to be supported by something concrete: customer retention rates, referral patterns, pricing power, proprietary technology or a service quality that competitors demonstrably do not match. Unsupported claims about market position do not survive due diligence.

The asset base and its contribution to value

In most service businesses, the fixed asset base is a relatively minor component of value compared to the earnings multiple. But in asset-intensive businesses, plant, machinery, property and equipment can contribute materially to the overall price and need to be assessed separately from the earnings-based valuation.

The condition and remaining useful life of significant assets directly affects value. Assets that are modern, well-maintained and have years of productive life remaining contribute positively. Assets that are ageing, require significant investment or are approaching end of life are a cost a buyer will factor into their offer.

Outstanding finance on assets, such as hire purchase agreements or finance leases, reduces the net value of those assets to the seller and needs to be understood and factored into expectations of net sale proceeds before the business goes to market.

Where the business owns its premises, the property is typically valued separately from the trading business and the two elements are considered independently. A freehold property adds value, but its value is driven by property market factors rather than business performance, and the two should not be conflated.

The lease position for property-dependent businesses

For businesses that operate from leasehold premises, the quality of the lease has a direct effect on value. A long lease at a market rent with straightforward assignment provisions is an asset. A short lease, an imminent rent review or onerous repair and reinstatement obligations are liabilities that reduce the attractiveness of the business and the price a buyer is willing to pay.

Buyers and their lenders need a lease term that gives them sufficient security to recover their investment. A lease with fewer than five years remaining is a concern for most buyers and a dealbreaker for some lenders. Where the lease is short, sellers should approach the landlord about a renewal before going to market, since a renewed or extended lease can have a meaningful positive effect on the sale outcome.

Compliance, regulatory and legal risk

Buyers assess the risk profile of a business alongside its earnings, and regulatory or legal issues that are unresolved at the point of sale create uncertainty that is invariably priced into the offer.

Unresolved compliance issues, outstanding legal disputes, tax irregularities, employment tribunal claims or planning concerns all reduce value and in some cases make a business very difficult to sell until they are addressed. The due diligence process is designed specifically to identify these issues, and sellers who hope that problems will go unnoticed are regularly disappointed.

The best approach is to identify and address known issues before going to market. Where issues cannot be fully resolved, being transparent about them from the outset and presenting a credible plan for resolution is significantly better than allowing a buyer to discover them during due diligence and use them as a basis for a late-stage renegotiation.

Timing and market conditions

The same business can achieve different prices at different points in time, depending on the economic environment, the level of buyer activity in the sector and the availability of acquisition finance.

A seller who goes to market when buyer appetite in their sector is strong, when finance is available on reasonable terms and when their own business is performing well is in the strongest possible position. A seller who is forced to sell during a downturn, when buyer appetite is reduced and lenders are more cautious, will typically achieve a lower price for the same business.

This does not mean that sellers should wait indefinitely for perfect conditions. It does mean that sellers who have a choice about timing should take market conditions into account alongside the performance of their own business when deciding when to go to market.

Final thoughts

The value of a private business is the product of a range of factors, some of which the seller can influence and some of which they cannot. The ones they can influence, most importantly the quality and evidencing of the profit figure, the degree of owner dependency and the condition of the lease and asset base, are worth attending to before going to market rather than leaving for buyers to assess on their own terms.

If you want to understand what your business is currently worth and what would make the most difference to that figure, get in touch with Blacks Brokers for a confidential conversation and a free valuation.

Sources

UK Government, Capital allowances: overview (tax treatment of business assets):
https://www.gov.uk/guidance/capital-allowances-overview

UK Government, Business asset disposal relief: eligibility and rates (capital gains tax on business disposals):
https://www.gov.uk/business-asset-disposal-relief

UK Government, Business lease renewals: the Landlord and Tenant Act 1954 (statutory right to renew a business lease):
https://www.gov.uk/business-lease-renewals

UK Government, TUPE: a guide to the regulations (employee transfer obligations on business sale):
https://www.gov.uk/transfers-takeovers

Financial Reporting Council, FRS 102: The Financial Reporting Standard applicable in the UK and Republic of Ireland (accounting treatment of assets and liabilities):
https://www.frc.org.uk/library/standards-codes-policy/accounting/uk-accounting-standards/standards-in-issue/frs-102/

UK Government, Corporation Tax: intangible fixed assets (tax treatment of goodwill and other intangibles in business sales):
https://www.gov.uk/guidance/corporation-tax-intangible-fixed-assets