How do you value a business and what is your business worth? Reply

Ultimately businesses will be valued through a process of negotiation between the buyer and the seller. There isn’t a single right answer, valuation isn’t an exact science.

The main reasons to value a business are:

  • Incorporation of a Sole Trader or Partnership
  • Divorce
  • Probate
  • Internal reward systems
  • Sale of the business or part sale

In order to value a business the valuer will need gather information such as

  • Financial Accounts
  • Management Accounts
  • Budgets
  • Forecasts
  • Details of liabilities
  • Asset Valuations
  • Market analysis
  • Client Contracts
  • Staff information and records

Not all this information will be available but essentially the more information that is available the more detailed and accurate the valuation will be.

The Valuer will also look at Strengths, Weaknesses, Opportunities, and Threats (SWOT).

The financials will need to be adjusted for exceptional and one off costs and any revaluation of assets and liabilities.

The Adjusted net assets then have a Goodwill or Bad Will adjustment applied to create the ‘Value of the Enterprise’

Lord MacNaghten in the case of Commissioners of Inland Revenue v Muller & Co Margarine (1901) AC215 defined goodwill as follows – he said:
“What is goodwill? It is a thing very easy to describe, very difficult to define. It is the benefit and advantage of the good name, reputation and connection of the business. It is the attractive force which brings in custom. It is the one thing which distinguishes an old established business from a new business at its first start. Goodwill is composed as a variety of elements. It differs in its composition in different trades and in different businesses in the same trade. One element pay preponderate here, and other there.”

The formula for Goodwill is

GW = Σ NCIt-rANAVt/(1+i)t

sometimes simplified to: GW = (NCI -rANAV)/i

GW = Goodwill

ANAV = operating adjusted net asset value

NCI = operating net current income

r = cost of equity

i = discount rate (weighted average cost of capital)

t = number of periods

In reality goodwill is much harder to establish in small businesses

Using Multiples is also a common approach to valuations, the multiple could be against

  • Sales
  • EBIT
  • EBITDA
  • Earnings per share (P/E ratio)

The multiple is assessed based on similar businesses which have been sold.

Another frequently used approach is Discounted Cash Flow (DCF)

The discount rate is usually the weighted average cost of capital (WACC)

WACC = ((ke x E)/E+D) + ((kd x D)/E+D)

WACC = weighted average cost of capital

ke = cost of equity capital

kd = cost of debt

E = Proportion of long-term funding from equity

D = Propertion of long-term funding from liablities

There are several ways in which DCF can be used to establish the business value.

Steve Bicknell holds the ACCA Certificate in Business Valuations and has carried small business valuations.

steve@bicknells.net

 

42 Business Valuation “Rules of Thumb” – are they right? 2

Looking at phone

 

I often get asked for ‘Rules of Thumb’ for small businesses, so I have searched the internet and compiled this list, do you agree with the ‘Rules’?

Rule of Thumb

Rules of Thumb are just a starting point and many other factors need to be considered in valuing a business, it also worth considering HMRC’s views (not so good for Chefs and Hairdressers)..

Any goodwill attributable to the personal skills of the proprietor, for example the personal skills of a chef or a hairdresser, will not be transferred to the new proprietor. Advice should be obtained from the CG Technical Group if it is claimed that the goodwill attributable to the personal skills of the proprietor have been transferred with the business because his/her services have been retained for the foreseeable future by means of an employment contract. All of the relevant facts and circumstances should be established before referral to the CG Technical Group.

http://www.hmrc.gov.uk/manuals/cgmanual/cg68010.htm

steve@bicknells.net

 

The tax benefits of goodwill on incorporation? 6

Business people

Lets start with a typical scenario:

  • Mr Smith has been running a small garage for a few years
  • he decides to incorporate his business and sets up Smiths Garage Limited with himself as the sole director and shareholder
  • he transfers the goodwill of the business and its other assets and liabilities to Smiths Garage Limited but does not claim incorporation tax relief under Taxation of Chargeable Gains Act (TCGA) 1992, s162, nor does he claim hold-over relief under TCGA s162
  • at the time of incorporation, the goodwill of the business is valued at £100,000
  • Mr Smith makes a chargeable gain on the transfer of the goodwill, which is deemed to be at market value, of £100,000 which, after deducting the annual CGT exemption (£10,900 2013-14), will be taxable at 10% due to the availability of entrepreneur’s relief (note rules changed 3rd December 2014 and ER is no longer available normal rates of CGT now apply)
  • the company will pay Mr Smith £100,000 for the acquisition of goodwill and this is done by way of a credit to Mr Smiths director’s loan account. Mr Smith is able to draw down on this account without any further tax charges.

In addition Mr Smith started his Sole Trader business after the 1st April 2002 so he can claim a corporation tax deduction for amortisation of the goodwill in the company accounts. Small Companies pay Corporation Tax at 20%, so being able to deduct Goodwill on £100,000 will save £20,000 in Corporation Tax. (note rules changed 3rd December 2014 and Section 849C CTA2009 prevents this on related party goodwill)

However, please bear the following in mind:

  1. If the business started before 1st April 2002, Corporation Tax Act 2009 s895 prevents the company from claiming a deduction against corporation tax, also refer to HMRC Spotlight 1: Goodwill – companies acquiring businesses carried on prior to 1 April 2002 by a related party
  2. Where a trader transfers his business to a limited company of which he is a ‘substantial shareholder’, the parties are treated as ‘related parties’ and the transfer must be at market value, but you can ask HMRC to carryout a post transaction valuation check by submitting form CG34
  3. Goodwill relating to personal services is not normally considered to have a market value as it can not be transferred
  4. In general it is expected that intangibles will have a useful life of no more than 20 years (note new rules – FRS102 states
    “If an entity is unable to make a reliable estimate of the useful life of goodwill, the life shall not exceed five years.”)
  5. Get professional advice to help you to prepare the valuation, disclose the capital gain and claim the tax relief

steve@bicknells.net