How to value a business: a guide for UK SME buyers and sellers

A UK small or medium-sized business is usually valued by applying a multiple to its adjusted, maintainable profit (often EBITDA), then cross-checking the answer against the value of its assets and, where the business is a practice, against its recurring fees. There is no single correct figure: valuation produces a defensible range, and the price is what a buyer and seller agree within it. This guide is for owners thinking about a sale and for buyers testing an asking price before they look for funding. Smart Funding Solutions is a broker, not a lender. We arrange acquisition finance from around £10,000 to £500,000+, with larger facilities available in suitable cases, and the way lenders look at value shapes how much of any price can be borrowed.

01The three main ways to value a business

Most SME valuations use an earnings multiple as the main method, with discounted cash flow and asset-based methods used to check or replace it where earnings are not the best guide. Each answers a slightly different question, so advisers often run more than one.

Method	What it measures	Best suited to	Main weakness
Earnings multiple	Maintainable profit multiplied by a factor that reflects risk and growth	Established, profitable trading businesses	Very sensitive to how profit is adjusted and which multiple is chosen
Discounted cash flow (DCF)	Today's value of forecast future cash flows	Businesses with predictable contracts or clear growth plans	Small changes in forecasts or discount rate move the answer a long way
Asset-based	Net assets at book or realisable value	Property-rich, asset-heavy or loss-making businesses	Ignores goodwill and earning power
Recurring revenue or fee multiple	Annual recurring fees multiplied by a factor	Accountancy, IFA, insurance broking and similar practices	Can hide poor margins if used without a profit check

02Earnings multiples and maintainable profit

An earnings multiple values a business as a number of years of its sustainable profit, so the most important step is working out what that profit really is. Valuers rarely use the figure in the filed accounts as it stands. They calculate adjusted or maintainable EBITDA (earnings before interest, tax, depreciation and amortisation) or adjusted operating profit, which is the profit a new owner could expect to earn year after year.

Normalisation and add-backs

Normalisation removes items that would not continue under new ownership and adds costs a new owner would have to bear. Typical adjustments include:

• Owner remuneration. Owners often pay themselves a low salary and take dividends, or pay themselves far more than a manager would cost. The valuer substitutes a market salary for the role.
• Personal and discretionary spending. Family members on the payroll who do not work in the business, private vehicle costs and similar items are added back.
• One-off items. A legal dispute, a relocation, a large bad debt or a grant received once is stripped out in either direction.
• Related-party arrangements. If the business rents premises from the owner below or above market rent, the rent is restated at a market level.
• Trend. Valuers usually look at three years and the current year to date, and may weight recent years more heavily if the trend is steady.

Buyers and their accountants test every add-back. An adjustment that cannot be evidenced is usually rejected, which is why quality of earnings work forms a large part of due diligence when buying a business.

Choosing the multiple

The multiple reflects how risky and how durable those earnings are. Small owner-managed businesses tend to sit towards the lower end of the range seen in private company deals, while larger businesses with strong management, contracted income and growth attract higher multiples. Advisers look at comparable transactions in the same sector where they can find them, but published data on small private deals is limited, so judgement plays a big part. Be wary of any single sector multiple quoted without context.

03Discounted cash flow, briefly

A discounted cash flow valuation forecasts the cash the business will generate over a period, usually five years, and discounts it back to today using a rate that reflects risk. A terminal value is added for the years beyond the forecast. DCF is rigorous in principle and useful for businesses with long contracts or a clear investment plan, but for most owner-managed SMEs the forecasts are too uncertain to rely on alone. It is more often used as a sense check on an earnings-based figure.

Normalisation removes items that would not continue under new ownership and adds costs a new owner would have to bear.

04Asset-based valuation

An asset-based valuation adds up what the business owns, less what it owes, and is most relevant where assets rather than profits drive value. Freehold property, plant, stock and debtors are restated at current or realisable values rather than book values. This method suits property-rich businesses, holding companies and loss-making businesses, and it sets a floor for value in many trading companies. Where a business owns its premises, the property is often valued separately and the trading business valued on its earnings after a market rent. Care homes are a good example of a sector where trading and property combine, covered in our guide to how to value a care home.

05Recurring revenue and fee multiples for practices

Professional practices are often priced as a multiple of their annual recurring fees, because the client bank is the main asset and fees tend to repeat each year. In accountancy, for example, a practice may be described in terms of a multiple of gross recurring fees, adjusted for the mix of compliance and advisory work, fee levels, client age profile and how much depends on the outgoing partner. Experienced buyers still check the profit the fees produce, because two practices with the same fee income can have very different margins.

The guides to selling an accountancy practice, selling a dental practice and selling a pharmacy explain how value is assessed in those sectors. If you are buying, our page on practice acquisition finance covers how lenders fund client banks and goodwill. In one completed case, we arranged a £137,500 facility for an established accountancy firm buying another practice, where much of the value lay in the client bank, recurring fees and goodwill; see the accountancy practice acquisition case study.

06What moves the multiple up or down

The multiple rises when earnings look durable and transferable, and falls when they depend on a few customers, the owner or conditions that may not last. The checklist below sets out the factors buyers and lenders weigh.

Factor	Tends to support a higher multiple	Tends to reduce the multiple
Customer concentration	Broad customer base, no single customer dominant	One or two customers account for a large share of sales
Owner dependence	Management team runs the business day to day	Relationships, pricing or know-how sit with the owner
Recurring income	Contracts, subscriptions or repeat annual fees	Project-by-project or one-off sales
Quality of earnings	Clean accounts, few add-backs, monthly management information	Heavy adjustments, late or inconsistent accounts
Growth	Steady, evidenced growth with a credible plan	Flat or declining sales, growth only in forecasts
Sector	Resilient demand, regulated barriers to entry	Cyclical, highly competitive or exposed to a single input cost
Size	Larger profit base and deeper team	Very small, owner-run operation
Working capital	Predictable, normal level delivered at completion	Volatile needs or a run-down position at sale

£137,500A transaction we arranged£137.5K to fund an accountancy practice acquisition.An established firm had an acquisition agreed. We structured the funding around the transaction and got it completed.

07Why lenders care about valuation

Lenders care about valuation because it tells them how much the buyer is paying relative to the earnings that will repay the debt, but they size the loan on those earnings, not on the price. A lender will typically ask what the business can afford to repay from cash flow after the new owner's salary, tax and capital spending, with headroom for a weaker year. That gives a maximum level of senior debt. If the price is higher than the debt plus the buyer's money, the gap has to be closed with deferred consideration, other forms of finance or a lower price.

This is why an inflated valuation causes problems at the funding stage. A seller may hold out for a figure based on a record year, but lenders will look at maintainable earnings and may treat some add-backs more cautiously than the seller's adviser. Our guide to the deposit needed to buy a business explains how the buyer's contribution and other layers fill the difference.

08Valuation, price and what a lender will fund

Valuation, price and lendable amount are three different numbers, and confusing them is one of the most common causes of failed deals.

• Valuation is an estimate of what the business is worth, usually expressed as a range.
• Price is what the buyer and seller agree, shaped by negotiation, competition, the structure (cash at completion or deferred) and what each side is giving up, such as warranties.
• The lendable amount is what lenders will advance, driven by affordability from maintainable cash flow, the security available and the buyer's track record.

Structure can bridge the gap. A seller who wants a higher headline price may accept part of it through vendor finance or deferred consideration, paid over time once the lender has been served. In practices, specialist goodwill finance can lend against the client bank where there are few hard assets.

09A worked example

Illustration only. The figures below are hypothetical and rounded, chosen to show the arithmetic rather than to suggest a market multiple. A distribution business reports profit before tax of £300,000.

Step	Amount
Reported profit before tax	£300,000
Add back interest and depreciation	£60,000
Add back owner's spouse's salary (no role in the business)	£30,000
Add back one-off legal costs	£20,000
Deduct market salary for a managing director, less the owner's current pay	(£60,000)
Adjusted maintainable EBITDA	£350,000

If buyer and seller agree that a multiple of four is fair for this business, the enterprise value is £1,400,000. That figure assumes the business is sold cash-free and debt-free with a normal level of working capital, so the seller would receive more if there is surplus cash and less if there are borrowings to repay. A lender might then assess how much senior debt £350,000 of EBITDA can support after tax, capital spending and the new owner's costs, and the answer may be well below the price, leaving the rest to the buyer's own money and seller finance.

10Getting a valuation you can rely on

A reliable valuation comes from clean financial information, realistic adjustments and an adviser who understands your sector. Prepare at least three years of accounts, current management accounts, a list of proposed add-backs with evidence, customer and contract data and a summary of the management team. Sellers often instruct a corporate finance adviser or accountant; buyers commission their own financial due diligence before committing. The ICAEW publishes guidance and can help you find chartered accountants with corporate finance experience.

11How Smart Funding Solutions can help