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Company Valuation

I am negotiating to take a third share in an IT company. The company in question has been trading for just over a year and provides mainly consultancy services but also retails hardware

Does anyone have any suggestions as to how I should value the company? T/O was £100k in the first year, with retained profits of £5k after dividends (other 2 shareholders are main employees and take most of their income through dividends)

Being mainly consultancy driven, tangible assets are fairly insignificant, the value being derived from goodwill

Also, are there any tax implications I should consider?

Thanks in advance
Mark Ward

Replies

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To continue.....
Well, as I say to many clients, a business, at the end of the day, is only ever worth what someone is prepared to pay for it..... Easily said from the seller's point of view.

My apologies for mis-interpreting your comment David, and to you too Mark.

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Sane advice
David
I completely agree. A random number generator would be just as useful, and take less time, than some suggestions. Suing some folk must be like taking candy from a baby on occassions, based on level of competence and knowledge implied by some responses.

Most (all?)professional bodies have a stricture that you should only undertake work/advice where you have the competence to do so. Why on earth most accountants seem to assume that, whatever their experience and expertise, they are qualified to value businesses completely baffles me. The same people would not dream of advising on indirect taxes in Outer Mongolia, yet they have comparable expertise.

I love it when I come across such instances in real life - as long as I'm on the other side!!

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Why are u considering buy any interest in the co ?
I have been involved with such co's. and I wd start with the question why are u interested. ?
Are u there accoutant, do they simply need funds.
consider other options , lend them money rather than invest, with usual options. see how they progress
before commiting capital.
They have nothing to value except their potential.
and that depends on good health, and commitment .
My involvement with such co's, was hughly successful £250k to £1.5m in 2 years,to begin with, but with success came the problems..i,e
"i thought of the idea I should own a bigger %", and then comes the interference from family and friends. (all that money in the bank ?) and success turns to disaster.
When or if you become involved, dir contracts and
main shareholders agreements are essential..and should not be put off..do it at the begining/
Within last 2 years know of..similiar type business same turnover etc..2 original dir/sh..broke up as one stopped working ?. just played about..
take care and time when making up your mind

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IR35?
Have you seen the contracts for consultancy they have undertaken or are currently undertaking? Is there a risk they could be caught by IR35, incurring additional tax, NI, interest and penalties?

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Share options instead?
Robert Maas's thoughtful contribution indirectly inspired the following idea.

Have you considered share options? If EMI options are possible (as they probably are from the facts given) there need not be any tax disadvantages for you or the company, and you can decide whether to become a shareholder at a later date when the company has become more established.

Although not a requirement of the EMI legislation, the current (fiscal) value of the relevant shares can be agreed with the Inland Revenue before the options are granted thus addressing Robert's point about having some independent opinion of value (since you will need professional advisers to negotiate with the IR).

Using EMI options also has the advantage of giving you certainty of tax treatment. The legislation on employment-related shares is proving to be complex and controversial in some respects, but in the context of EMI it is established and clear.

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ignorance may not be bliss
I am truly astounded by some of the replies to this question, which imply you can conduct a company/share valuation by means of a finger in the air (oh, 1x or 2x or 3x turnover, or was that net profit, or pre-divi income, or deduct the cost of marbles from the price of fish and divide by two). Blimey. I suggest you take the sane advice - talk to someone who has expertise. Start with the question "what generates value" rather than some kindergarden formula from a GSCE paper. Jeez, I'd love to be negotiating a share price with some of the folk posting comments on this question!!

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David's position
I think in fairness to the other comments posted, David (correct me if I'm wrong) is suggesting that this is a discussion board, rather than somewhere for people to obtain free advice..... I am sure someone said much the same recently, and one has to agree - we've all got mortgages.... most of us, anyway!

Nonetheless, good luck with it Mark, and make sure that there are contracts in place to ensure turnover and profits are recurring, at least to some extent!

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Valuation
I think 3x turnover is a rather high multiple to apply. 1x or possibly 2x would be more like. I agree with applying a discount to the 1/3. I also agree (writing as a lawyer) with the suggestion that they should have a shareholders' agreement and that it should cost about £500. I've seen plenty of fall-outs in which everyone has suffered because there was no provision for a parting of the ways. Businesses with three "partners" seem especially prone.

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Is it appropriate to look at turnover?
The shares can only have a significant value if the profits of the company are expected consistently to exceed the aggregate commercial remuneration of its directors (and other employees). The fact that the two existing directors currently take dividends rather than salaries is irrelevant in this context.

With turnover of £100k and three senior employees (including you) to remunerate, the value of the shares looks pretty low to me unless you are expecting a sudden and spectacular increase in profits.

Apart from valuation watch out for the unpleasant and complex income tax rules on so-called "employment-related" shares. It's best to take expert advice on this.

I would also reiterate the importance of having a shareholders' agreement. Usually completely superfluous until there is a disagreement but it's then indispensable. Take advice on the drafting of this from a lawyer, not an accountant (I am an accountant!), as it is vital that it is not at odds with the company's constitution or the relevant legislation.

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Business Valuation Software
Hello Mark. As a useful tool that many advisers use as part of the process in valuing companies you could take a look at the Valuer software which is available from AccountingWEB.

Visit: Business Valuation Software for more information.

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Valuation?
A year in and they want how much? Walk!

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Valuation
Mark, it is not necessarily as complex as David would have you think, though it can be in fiscal valuations.

This looks like a purely commercial transaction, and I presume that since the start of trade there have been no other share transactions upon which you could base a valuation.

As the company appears to have no assets and no real trading record on which you can rely, you need to base the valuation on a multiple (say x 3 at such an early stage) of likely future profits (before dividends). Make adjustments for any one-off costs and revenue's, so that they do not distort your figures. Also, if only a low directors salary has been included - because most has been taken as dividend - you need to include a reasonable salary deduction from profits.

Alternatively, look at what kind of return you are looking for on your investment, for say a 4-5 year investment? 50%+ for a high risk? Is there a future exit route for your investment (e.g. a possible trade sale or share buy back)?

That means seeing the detailed business plan of the company and talking to the directors about their plans. The quality of the customer base and the value of any contracts in place also needs to be assessed.

When you have arrived at a figure for the profit x multiple, you need to divide that by 1/3 for your share and deduct a further 50% discount off that for the uncertainty and lack of marketability. This is negotiable.

So e.g., Future profit after adjustments = say £100,000 x multiple of 3 = £300,000. Divide this by 3 = £100,000 and knock off 50% = £50,000. So £50k would be the price you would pay for the shares. The actual price depends on the actual figures and how confident you are of the company's viability.

As long as there is no guaranteed return and the company is issuing you with new shares, your investment may qualify for EIS relief - see IR137.

Hope this helps

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Shareholders agreement
One thing you may want to pay a lawyer for is a shareholders agreement, which will protect your investment and give you certain rights.

Most decent law firms will have a standard agreement for you to complete the blanks. Typically they will charge £500+, depending on how much negotiation there is over the agreement.

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