How to value a business for equity give away?
Discussion
Fairly vague but I have a friend that is willing to invest some cash into our business.
Is there a “rule of thumb” when valuing a business so I know what would be a fair percentage stake to give away? I obviously want to give away as little as possible but want to make it fair for both of us.
Eg if the business made £100k net profit would we be taking about £100k investment for 20%. The investment could also help the company quickly double its turnover/profit within a couple of years.
Not having a clue about this sort of thing I would appreciate any advice before making the wrong decision! Thanks.
Is there a “rule of thumb” when valuing a business so I know what would be a fair percentage stake to give away? I obviously want to give away as little as possible but want to make it fair for both of us.
Eg if the business made £100k net profit would we be taking about £100k investment for 20%. The investment could also help the company quickly double its turnover/profit within a couple of years.
Not having a clue about this sort of thing I would appreciate any advice before making the wrong decision! Thanks.
Same rules apply as when trying to value a business for sale.
The rule being... generally, there is no fixed rule!.
Equity is only really of any use when sell up time comes so, if it were me, I would look to try and base any decision on potential future sale price rather than looking at Profit for the last 12 months past.
Hard to quantify now, as you say the investment should hopefully drive revenue, which in turn will increase your potential sale price in the future.
Sounds too simple... however start low and see what traction you get....
RM
The rule being... generally, there is no fixed rule!.
Equity is only really of any use when sell up time comes so, if it were me, I would look to try and base any decision on potential future sale price rather than looking at Profit for the last 12 months past.
Hard to quantify now, as you say the investment should hopefully drive revenue, which in turn will increase your potential sale price in the future.
Sounds too simple... however start low and see what traction you get....
RM
Edited by BerksBoy on Wednesday 11th February 15:33
BerksBoy said:
Same rules apply as when trying to value a business for sale.
The rule being... generally, there is no fixed rule!.
Agree with that.The rule being... generally, there is no fixed rule!.
BerksBoy said:
Equity is only really of any use when sell up time comes so, if it were me, I would look to try and base any decision on potential future sale price rather than looking at Profit for the last 12 months past.
Two false things here:i) Equity is not just used for dividing assets in a liquidation or proceeds of a sale. It's also used for profit distributions i.e. dividends.
ii) You can't value a business on the basis of future potential. You have to value you it TODAY. Otherwise you're making the investor 'pay' for their future profits and there's no upside for investing. The entrepeneurs (not dragons) on Dragons Den frequently make this mistake and hence wildly over value their company, as they are thinking about future value not current value.
The starting point for valuations depends on the type of business. If it's an investment business (i.e. holds property etc) then value the assets. If it's an enterprise business (i.e. trading and generating cash) then value the revenue stream.
Valuing the enterprise is generally done based on a price to earnings multiple (or ratio). So basically look for similar companys and compare their earnings (either PAT or EBITDA or whatever) to their company value. Do this for a few similar businsses and it will give you an idea of the range of P/E ratios for your type of business. Multiply your earnings by this ratio and it will give you a starting point for your valuation.
If there's anything peculiar about your company then adjust up or down, since the P/E calculation is just the starting point.
HTH.
PS - I'm a Chartered Accountant and valuations is one of the things I do reasonably regularly.
Having recently closed a round of friends and family fundraising - discounted cash flow is a reasonable way to determine value. Alteratively look for valuations of bigger companies in the same business, and look at the earnings ratio applied to determine value, then offer a discount as an incentive to offset the risk.
Most people have gut feel of what sounds right, but you need to make sure that you protect the value of your company and don't give away too much - especially if you are using EIS or CVS schemes to offer the tax advantage for your friend, it can look suspicious to the revenue.
Phil.
Most people have gut feel of what sounds right, but you need to make sure that you protect the value of your company and don't give away too much - especially if you are using EIS or CVS schemes to offer the tax advantage for your friend, it can look suspicious to the revenue.
Phil.
Windsorphil said:
discounted cash flow is a reasonable way to determine value.
True, but you need a reasonable idea of what future cash flows will be, and then you also need to be able to determine an appropriate discount factor to calculate the present value. These are not particularly easy in the real world, but it is a pretty good technique if you can get reliable data to feed in.Rule of thumb is to look at a multiple of profits. So if your business made £100k, then I would say in the current environment it has a multiple of 3 or 4 times (and this multiple REALLY depends on the business, mind) so your business is worth about £3-400k. If he puts in £100k for 20% that sounds close to the mark.
This is a very rough measure though and with an investment of this size both parties should be asking an independent third party to do a valuation here.
Just one thing, if he is going to do this then he should REALLY do it under the Enterprise Investment Scheme (EIS). If he's a top rate tax payer (and if your business is a qualifying business) then he puts in £100k, will get £20k back from the govt off his tax bill plus all profits he make are CGT-free and if the business goes under he will get a further £32k (40% of his net £80k) investment tax relief! You've got a few hoops to jump through so ask your Accountant about it but it would be senseless not to do it this way if it were possible.
This is a very rough measure though and with an investment of this size both parties should be asking an independent third party to do a valuation here.
Just one thing, if he is going to do this then he should REALLY do it under the Enterprise Investment Scheme (EIS). If he's a top rate tax payer (and if your business is a qualifying business) then he puts in £100k, will get £20k back from the govt off his tax bill plus all profits he make are CGT-free and if the business goes under he will get a further £32k (40% of his net £80k) investment tax relief! You've got a few hoops to jump through so ask your Accountant about it but it would be senseless not to do it this way if it were possible.
Most of the usual stuff covered well in other posts. However just one thing to flag up....
There are upsides to doing business with chums but you also need to be aware of the downsides too.
EINSIGN said:
I have a friend that is willing to invest some cash into our business.
The relationship you have with people outside of the business place is very different to that you have within it. Your friend may be a great friend but regardless of this, they will want to see a return on their investment. If this doesn't happen or not the level they expect, that can sour your friendship.There are upsides to doing business with chums but you also need to be aware of the downsides too.
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