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Article: Valuing your business – an introduction by Helen Reynolds

How much is a business worth - and how can you create more value? 

These are two burning issues for anyone in the recruitment sector who may want to value a business, to help buy or sell it, to raise equity capital, to create an internal market for shares or to motivate management. 

One of the main factors that will affect how much a business is worth is the reason why you are seeking the valuation in the first place and the circumstances surrounding that valuation. Is it a forced sale? How old is the business? What are its tangible assets? What are the monthly billing rates? What is the future profit potential?

One of the most important things to remember is that like everything else in recruitment, value is driven by the simple rules of supply and demand and a business, like a candidate, is worth what someone is willing to pay for it. 

But how do you get to the figure that someone should be willing to pay?

Asset valuation – This is a good method to use if a business is stable and rich in assets, for example if you own your premises. In the simplest of terms, add up your assets and take away your liabilities. However, this takes no account of future earnings potential and probably shouldn’t be considered on its own when valuing a recruitment consultancy.

Price earnings ratio – This is the value of the business divided by its profits after tax and is appropriate to use if the company has a sustained track record of profits. Multiply the business’ most recent profits after tax by the relevant Price-Earnings (PE) ratio. Ratios vary widely and quoted companies will have a higher PE ratio than unquoted companies. You can get an idea of PE ratios from publications such as the FT, which gives historic figures for different industries. A small unquoted business would normally be looking at a PE ration of between 5 and 10.

Entry cost valuation – You may want to start a new business from scratch and this method looks at what this process would cost - so it would include factors such as recruiter salaries, rent or purchase costs of premises and equipment and initial marketing costs.

Discounted cash flow – For businesses who have invested heavily and are forecasting steady cash flow in the future, this is the most technical way to value a business. It is dependent on assumptions about long term business conditions and is based on dividend forecasts and a residual value at the end of a certain period - at least 15 years. Explain briefly what Discounted cash flow is.

Industry rules of thumb – These tend to be used in sectors where the buying and selling of businesses is very common. The formulas used vary but may include expected turnover, number of clients and outlets - a lot depends on what the buyer feels the business is worth to them in terms of its extra turnover or profit potential. 

However, there are also other intangible issues which cannot be measured in this way, but are key to a business’s value such as a strong brand or an effective management structure, for example. However, there are also risks. If your business is successful because of people - and those people leave - or because of an excellent set of regular clients, which are lost, then this is going to affect the value of the business. So, make sure you take care of relationships with clients, that your employee contracts are watertight and that you have a sound talent retention strategy.

Finally, if you are looking at buying a business in the recruitment sector, you need to work out its true profitability. Compare the profits stated by the current owner to the audited figures and look for costs which you could reduce, for example on premises and external suppliers. Look for areas to ‘restate’ (to change a figure from one kind of cost to another) and when looking at future profits, bear in mind the cost of achieving them. 

Helen Reynolds is Managing Director of HB RIDA, a joint initiative between James Caan’s Hamilton Bradshaw Private Equity and The Recruitment Industry Development Agency. A business coach and entrepreneur she provides support to fledging and established businesses through a unique set of development programmes assisting recruitment business owners to grow and develop their own firms. 

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