One shareholder wants to sell their shares. Another shareholder wants to buy. But what price should you pay? Is it fair? How do you know?
Valuing shares in a private company is part art, part science. Unlike public companies where you can look at the share price, private company valuations require judgment. Get it wrong and one party feels cheated. Get it right and everyone can move forward fairly.
Why share valuation matters
Fair valuation matters for several reasons. Legally, if the price is unfair, the seller can claim the deal was unfair or fraudulent. Practically, if the price feels unfair, the departing shareholder is resentful and may take legal action or non-comply with non-compete clauses. Tax, HMRC cares about the price for tax purposes. Too low a price and HMRC might argue it wasn't genuine. Too high and you're paying excess tax.
That's why shareholders agreements often specify a valuation method in advance. Rather than figuring it out when emotions are high, you agree in advance on the formula. This removes room for dispute.
The main valuation methods
Earnings multiple (P/E multiple). Company profit multiplied by a multiple. Example: "Shares are valued at 5x EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization)." If the company makes £100,000 EBITDA, the company is worth £500,000. If there are 10,000 shares outstanding, each share is worth £50.
How to determine the multiple? Look at comparable companies in the industry. Tech startups might trade at 10-15x revenue or 30-50x EBITDA if profitable. Mature businesses trade at 3-5x EBITDA. Financial services might be 4-8x. The higher the growth rate and margins, the higher the multiple.
This method is intuitive and common. It ties valuation to profitability, which makes sense. But it depends heavily on the multiple you choose.
Revenue multiple. Company revenue multiplied by a multiple. "Shares are valued at 2x annual revenue." If the company makes £500,000 in revenue, it's worth £1,000,000. With 10,000 shares, each share is worth £100.
Revenue multiples are useful for early-stage or loss-making companies where EBITDA is negative. But they ignore profitability, so they can overvalue unprofitable businesses. Generally used as a temporary valuation until profitability is clearer.
Discounted Cash Flow (DCF). Project future cash flows and discount them back to present value. More complex but theoretically most accurate. Requires forecasts and assumptions.
Example: "We project £50,000 free cash flow next year, £75,000 the year after, £100,000 the year after. Discounting at 15% (risk-adjusted), present value is £280,000." With 10,000 shares, each share is worth £28.
DCF is used for larger businesses and when seeking professional investment. It's harder to argue with because it's based on forward-looking projections. But it requires credible forecasts.
Book value (net assets). Assets minus liabilities, divided by shares. "Shares are valued at net assets per share." If the company has £500,000 in assets and £200,000 in liabilities, net assets are £300,000. With 10,000 shares, each share is worth £30.
Book value is simple but often undervalues successful businesses. A software company with £100,000 in book value but generating £500,000 in revenue is worth far more than £100,000.
Market comparison. "Similar companies recently sold for X multiple." If you know that a comparable business sold for 4x EBITDA, use that multiple. This is the most practical method for private businesses.
The challenge: finding truly comparable companies and recent transaction prices. But if you can find them, this is convincing.
Hybrid / tiered formula. Combine methods. "For the first £100,000 of EBITDA, value at 5x. For EBITDA above £100,000, value at 3x." Or: "If EBITDA is below £50,000, use 2x revenue. If between £50k-200k, use 3x EBITDA. If above £200k, get an independent valuation."
Hybrid approaches are common in shareholders agreements because they're pragmatic: they account for different business stages and remove the need for expert valuation unless the company is large.
Factors that affect valuation
Beyond the method, several factors affect what's reasonable:
Growth rate. A company growing 50% per year is worth more than one growing 5%. Higher growth = higher multiple.
Profitability. A profitable company is worth more than a loss-making one. If you're using an earnings multiple, only profitable companies can be valued this way.
Market and competition. Is the market growing or shrinking? Are there strong competitors? A company in a growing market with limited competition is worth more.
Customer concentration. If 50% of revenue comes from one customer, that's risk. Lose that customer, valuations drops. More diversified customer bases justify higher valuations.
Team and management. A company with a strong team and clear processes is worth more than one dependent on a single founder.
Stage and risk. Early-stage companies are riskier and warrant lower multiples. Mature, stable companies warrant higher multiples.
Time of year and tax considerations. If you're selling in March (just before tax year end), you might value lower to get a tax deduction in the current year. These considerations affect negotiations but shouldn't affect "fair" valuation.
What's fair in different scenarios
Startup with no revenue. Usually valued at cost (how much did investors put in) plus maybe a small uplift. Or using a SAFe or advance subscription round. Hard to value with traditional methods.
Early-stage, pre-profit. 2-4x revenue multiples are typical. If the company is bootstrapped and founder-funded, it might be 1-2x revenue or just net assets.
Growing, marginally profitable. 5-10x EBITDA or 2-3x revenue. Depends on growth rate and market.
Mature, stable and profitable. 4-8x EBITDA, depending on the industry. Services companies tend to be lower (3-5x), tech and software higher (8-15x).
These are guidelines, not rules. Actual valuations vary based on specifics.
What happens when shareholders disagree on valuation?
If a shareholders agreement specifies a method but parties disagree on interpretation (e.g., how to calculate EBITDA), the agreement should specify how to resolve it:
Expert determination. A neutral independent accountant or valuer determines the value. Both parties submit their case and the expert decides. It's binding. This is common and fair.
Mutual agreement. The shareholders must agree on a price within 30 days or proceed to expert determination.
Shotgun clause / Russian roulette. One shareholder proposes a price; the other can force them to buy or sell at that price. Incentivizes fairness because you have to be willing to accept your own offer.
If the shareholders agreement doesn't specify a method, you're left negotiating. This can be contentious, which is why having an agreed method in advance is valuable.
Tax considerations
HMRC cares about the valuation for capital gains tax and inheritance tax purposes. If you sell shares for less than their "fair value," HMRC might argue you owe more tax (treating the difference as a gift). If you sell for more, HMRC is usually fine.
For transactions between related parties (e.g., co-founders), HMRC applies an "arm's length" test: what would unrelated parties pay? If your valuation is significantly off, HMRC can challenge it.
For this reason, it's worth documenting your valuation method and the reasoning. If you use an independent valuation expert, that carries weight.
Getting it right
If you're negotiating a share purchase or sale, use QuickLegalCheck to review the valuation method and ensure it's fair and defensible.
Or if you have a more complex situation, see a sample report of the kind of analysis we provide.