Time and again on Dragons’ Den the entrepreneurs fall down on the valuation of their business. They stand before the Dragons and ask for too much money for too little equity, and the Dragons always notice.
After this, the best the entrepreneur can hope for is that the Dragons will ask them for a lot more of their business than they planned to give away. At worst, they will leave with nothing. Here are six tips to help you to avoid those mistakes
1) Understand your finances
Any investor, Dragon or otherwise, will want you to have a clear understanding of your finances. Even if you’re not currently seeking investment, knowing where the money is going in your business is essential if you want to manage it effectively.
To arrive at an accurate profit figure, subtract your business’s expenditure from your income. Your gross profit is the simplest figure, as it is the difference between your sales revenue and the cost of the goods sold.
Net profit, however, is a better reflection of how your business is doing. To calculate your net profit, you will need to subtract all your business’s expenses, including any taxes, from your revenue. A great gross profit is useless if your net profit is non-existent.
2) Predict realistic growth
Your current profits are just the first thing to consider in a valuation. It is also important to tell an investor where you expect to be over the coming years. Most investors are not interested in just buying a slice of the business for the short term - they want to see a return on their investment over a longer period of time.
Depending on how much you think the business will grow, you should multiply your most recent profits by three to five times. Unproven or smaller businesses should be more cautious, whereas bigger businesses can make bolder predictions. The figure you end up with should give a good idea of where you expect your business to end up in the next few years if everything continues according to plan.
3) What assets do you hold?
Another way to value your business that might represent a more accurate picture of its worth, depending on what you do, is to look at the value of the assets that the business holds.
Your assets are basically anything the business owns with a monetary value. For example, a construction company might own tools, equipment, vehicles and more. Any property that the business owns and any current stock are all considered assets. Even an online business can have a significant asset in the form of a domain name, especially if it’s sought after.
If you are using your assets to guide your valuation, you also need to take into account any liabilities that the business has. The assets that you have should be valued at the current market rate, and won’t take into account any changes in the market.
There are a range of factors to take into account when it comes to the valuation of your business. Alongside your profits and any assets that the business holds, a good location with a strong customer base is a big boost to your valuation. Any buyer looking to take over a business like that would have to pay a lot of money for the privilege, so don’t just look at your balance sheet and forget about this factor.
5) Your progress is worth something
Anyone looking to buy some or all of a business will likely benefit in some way from the progress that the business has already made in establishing a place for itself in the market.
As an example, one area that is particularly difficult to break into from scratch is the app market. If you have already made built a loyal customer base, investors will recognise the progress that you have made and your business will look a lot better.
It is hard to put a price on the value of your business’s progress, so it should not be seen as the primary guiding factor in your valuation, but it is worth bearing in mind as something that can impress investors, and support a higher valuation.
6) And don't forget...
There are a number of other factors that shouldn’t necessarily guide the valuation, but can make a difference. Two important examples are your historical finances, and any protected products or patents that the company owns. Both of these factors show investors that your business can be successful, and has future potential.
Other things to bear in mind include any debt that the company owes, how much money your competitors are making, and what your reputation’s strength.
Valuing your business correctly involves knowing it inside and out. Consider every aspect of the business when you make the valuation, not just the most obvious.
By David Weiner, Company Address