A PRACTICAL (AND PAINFULLY HONEST) HANDBOOK FOR VALUING A BUSINESS

Written by Matthew Brittain

Valuing a business is one of those activities that everyone claims to understand until they are asked to do it properly. It occupies a strange space somewhere between mathematics and mythology. On the one hand, we pretend it's a discipline governed by rational finance and sober calculation. On the other hand, the process routinely descends into wishful thinking, selective memory, and the cheerful manipulation of numbers until they produce an answer someone finds emotionally satisfying. And this is before we mention advisers, many of whom wield “adjusted EBITDA” like an enchanted talisman that wards off reality.

Yet businesses must be valued. Deals depend on valuation. Bank lending depends on valuation. Share transfers, exits, tax events and even family disputes depend on valuation. So we might as well do it properly, or at least as properly as the real world allows.

What follows is a handbook written for founders, buyers and anyone else forced to stare at spreadsheets long enough to start questioning their own mortality. It draws on the habits of world-class investors, the mistakes of less world-class accountants and the general principle that a valuation should be something sturdier than optimism held together with PowerPoint.

The first thing to understand—really understand—is that you are not valuing a set of accounts. You are valuing a future stream of cash that may or may not materialise. Accounts are merely the archaeological record of what the business has done, not a prophecy of what it will do. If the person presenting the valuation hasn’t mentally detached themselves from the accounts, it’s a sign the number they are about to produce should be taken with the same seriousness as horoscopes.

Before we dive into methods, it helps to categorise the type of business you’re looking at. Not all companies should be treated equally. Manufacturing firms with warehouses and machinery behave very differently from asset-light agencies or software companies built around intellectual property. Then there are the majority of UK SMEs—owner-dependent enterprises where the founder holds together operations with little more than habit, force of personality and a mobile phone that never stops ringing. To value these businesses as though they were autonomous corporate organisms is to engage in fantasy.

Once you know what you’re valuing, you can choose your method. The gold standard of valuation, at least according to finance textbooks and finance students who haven’t yet met human behaviour, is Discounted Cash Flow. DCF is theoretically perfect: take the future cashflows, discount them back to today, and voilà—you have a valuation that reflects economic reality. In practice, however, DCF is only as sensible as the assumptions you feed into it. It suffers from chronic sensitivity. Change a growth assumption by a single percentage point and the valuation may jump or collapse dramatically. Adjust the discount rate slightly and you could be valuing the same business as either a delicately undervalued gem or an impending write-off. DCF is a tool of precision, but it requires someone with a steady hand and no incentive to fiddle the inputs. Unfortunately, most valuations are conducted by people with very strong incentives indeed.

This is why the UK, especially in the SME world, leans so heavily on the multiples approach. Multiples are simple, fast, easy to explain and even easier to manipulate. EBITDA multiples. EBIT multiples. Revenue multiples. Pick your metric, multiply it by something that sounds credible, and you can produce a number that looks impressively authoritative. The trouble is that a multiple is not a fact. It is a mood dressed up as mathematics. A sector trading at 8x EBITDA one year may languish at 4x the next, not because the businesses have suddenly deteriorated, but because investors have. Multiples, in other words, are a short-hand expression of risk, sentiment and the expected stability of earnings. When someone applies a tech-company multiple to a suburban plumbing firm because they saw it in a magazine, you can safely assume the valuation has left the realm of sanity.

Asset-based valuation has its virtues too, especially for businesses with heavy physical infrastructure. If the business owns property, machinery or equipment, there is logic to starting from its net asset value. But the most dangerous mistake in asset valuation is assuming that all value sits in the physical world. Many companies—especially care providers, consultancy firms, specialist contractors and service businesses—derive their actual value from relationships, brand reputation and operational know-how. None of these appear on the balance sheet, and attempting to value such a business purely on its tangible assets is a bit like valuing a violin by weighing it.

Then there are comparables, the market’s attempt to justify a valuation based on what similar businesses have sold for. The problem is that few businesses are genuinely comparable. Geography, customer mix, regulatory environment, margins, management team and even the charm or chaos of the founder can change a valuation dramatically. The number one sin committed in pubs and golf clubs across Britain is declaring, “My mate sold his company for 10x earnings, so mine must be worth the same.” The only accurate response to this is: probably not.

Accountants, for all their virtues, frequently get valuation wrong because valuation requires imagination. Not fantasy, not hope, but imagination in the sense of understanding how the business behaves as a living organism. Accountants excel at historical accuracy. Valuation demands judgement about the future: the competitive landscape, the durability of contracts, the reliability of staff, the risks hidden in cashflow timing and working capital. Many accountants apply rigid sector multiples without adjusting for nuance. They ignore the human element. They often treat the founder as replaceable even when the founder is the only reason customers continue paying their bills. In fairness to them, this problem is created not by accountants but by the accounting profession, which has conditioned people to believe that the P&L tells the whole story.

So what does work? The best investors blend methods. They take a normalised version of cash earnings—stripping out the founder’s perks, the one-off costs, the creative accounting adjustments—and then apply a sensible, sector-appropriate multiple. But they do not stop there. They adjust for growth credibility. They adjust for management dependency. They adjust for concentration risks, competitive threats and capital requirements. In other words, they value the business that exists, not the one being pitched.

A simple, sceptical formula—appropriate for British business reality rather than Silicon Valley aspiration—might look like this:

Value ≈ (Normalised Cash Earnings × Sensible Sector Multiple) ± Growth Reality ± Management Dependency ± Strategic Premium

Growth reality matters more than people think. Many founders produce projections in which next year mysteriously looks like a golden age of operational competency and customer enthusiasm, despite no evidence that the business has ever behaved that way before. A buyer must ask whether the business has the systems, talent and commercial structure to deliver the projected growth. Almost always, the answer is “not without hiring more people, increasing costs or rewriting half its processes”—all of which suppress valuation.

Management dependency is the great killer of SME valuations. Buyers hate key-person risk because it creates volatility, and volatility destroys multiples. If the founder does the selling, the customer management, the quality control and half the operations, then the buyer isn’t valuing a business—they are valuing a person whose employment may expire the minute the cheque clears. Many businesses that look marvellous on paper are fundamentally unsellable because they are founder-shaped organisms with no ability to survive in the wild.

Strategic premiums are the mysterious bonus layer that occasionally appears when a buyer can make more money from the business than the business can make itself. Cross-selling opportunities, operational synergies, geographic expansion and defensive value (buying the company simply so a competitor can’t) can all create premiums. But these premiums exist only for one buyer, and often only once. Treat them as a happy accident, not a core part of valuation.

Now let’s turn to the pitfalls—the areas where valuations routinely go wrong. The most common is the misuse of adjusted EBITDA, a number that sometimes bears only passing resemblance to the profit the business actually generates. Add-backs are legitimate when used sparingly and transparently. Too often they become a bucket for every dubious reclassification. If you find a seller adjusting EBITDA for “owner fatigue”, “opportunity cost” or “unusually warm weather”, it is best to close the file.

Another common error is forgetting working capital. A business may appear highly profitable but require so much cash to fund its receivables that its operational value is far lower. Growing firms often consume cash rather than produce it. That reality should reduce valuation, yet too many sellers assume growth deserves a premium even when it drains liquidity.

Then there is customer concentration. A business that gets 40% of its revenue from one client does not deserve a hero’s valuation. It deserves a haircut. If that customer leaves, the EBITDA vanishes. When sellers say “don’t worry, they’ve been with us for years”, buyers hear “founder hasn’t bothered to diversify risk”.

It must also be said that projections are mostly works of fiction. Some are optimistic fiction, some are dystopian fiction, but fiction nonetheless. Basing valuation on next year’s projected EBITDA rather than last year’s actual EBITDA is an excellent way to overpay. Anyone who has covered corporate collapses knows that overpayment is not an accounting error; it is a human one.

Buyers make mistakes too. They fall in love with the story instead of the numbers. They convince themselves they can fix cultural dysfunction with a memo. They underestimate capex. They assume technology is scalable because it exists. They think the founder’s enthusiasm will survive the transition from owner to employee, something that happens approximately as often as pigs take wing.

Sellers, meanwhile, cling to valuations based not on commercial logic but on retirement plans, ego or hearsay. They assume their business is more attractive than it is. They assume buyers will overlook issues that they themselves have ignored for years. They assume the valuation they need is the valuation the market will give them. Unfortunately, markets are not charitable organisations.

The best valuation approach is methodical rather than mystical. Start by understanding the financial engine of the business. Analyse whether earnings are stable, repeatable and well supported by contracts, processes and management depth. Examine customer mix. Understand churn. Review competitive positioning. Inspect the team. Assess cashflow quality, capital needs, seasonality and any pending liabilities. Then triangulate a valuation using multiple methods. If the methods converge within the same range, you are likely within shouting distance of the truth. If they diverge wildly, either your data is poor or the business is fundamentally odd.

Ultimately, valuation is about trust. Buyers must trust the numbers, trust the disclosures, trust the operational narrative and trust the seller’s willingness to hand over the business cleanly. The most valuable businesses are those with predictable earnings, low dependency on the founder, a diversified customer base and a management team capable of making decisions without phoning the owner at 10pm.

When these ingredients exist, the valuation writes itself. When they don’t, the valuation becomes a negotiation in which the buyer’s tolerance for risk collides with the seller’s tolerance for disappointment.

How Lexis Capital Group Helps

At Lexis Capital Group, we work with founders, buyers and investors to build valuations grounded in reality, not optimism. We analyse the commercial engine of the business, normalise earnings properly, assess hidden risks, benchmark sector multiples, evaluate management strength and prepare companies for the brutal scrutiny of due diligence. Whether you’re buying, selling or planning a future exit, we help you reach a defensible valuation, avoid the classic traps and present a business that buyers can understand, trust and value appropriately.