While accountants and solicitors will do their best to make this is an unfathomable task, it is actually surprisingly simple and easy.
Here are the basic rules:
A company is worth:
Tangible Assets + Performance + Intangible assets
If your company owns anything this has a value.
items such as buildings generally increase in value, items such as cars and computers generally decrease in value.
For decreasing items, calculating the value is straight forward:
Value = Purchase price – Depreciation
Depreciation can be calculated easily.
For example, if you bought a computer for £500 used it for 3 years and then sold it for £200, then annual depreciation is £100. So after one years use the computer has a value of £400. This is born out if you can actually sell it for this value.
Tangible Assets also include cash in the bank which can be added and bad debts falling more than one year which can be subtracted.
For a profitable company with history a simple calculation is:
12 to 14 times the retained net profit after tax, averaged across the previous 3 years.
Buyers will lean towards 12 times, sellers will lean towards 14 times.
The negotiation that ensues is called the ZOPA or Zone Of Possible Agreement.
They even named a bank after that term.
The third valuation is Intangible assets and that is a view on a companies good will and future performance, growth and profit.
This is the hardest to define and the prime culprit for startups believing they are worth £1M.
In fact intangible assets becomes a very personal view point of the buyer and is the biggest variable in agreed price. In reality it is a gamble.
Next time: Lean startup vs. Fully Funded