How to ensure you're getting the right valuation for your business – and why it matters

By Scott Robson, Founder of Ambro Partners

Many business owners know their companies inside and out, yet they rarely know one critical fact – how much their company is actually worth. In this article we consider the different methods commonly used to value a business, take a look why it’s useful to understand the value of your business, and discuss the benefits of having an accurate valuation performed by a professional.

 

A company valuation, regardless the method you choose, is a process where the actual elements of the company are measured, as well as its competitive position within its sector and its future financial expectations.

When is an accurate business valuation useful?

There are many occasions when it it useful to have an accurate business valuation.  Smart business owners regularly review their company valuation and use it to validate if they are improving their business.  

Here are some examples of when you might need to rely on an accurate business valuation:

Change in ownership as part of succession planning or retirement

Merger or sale to another entity

New shareholder or partner coming on board

Going through a divorce

Gifting shares of a business to children as part of a succession plan

Raising investment capital

Establishment or annual update of an employee stock ownership plan (ESOP)

Estate tax purposes

‘Something is only worth what someone is willing to pay for it’

This very simple concept – thousands of years old – is one that definitely applies when it comes to valuing a company. Valuations are very personal, and are dependent on the who, what, why and when.

In an acquisition scenario, you should consider the following:

A) Who is the business/individual making the acquisition

Is the buyer a competitor, private equity firm, or perhaps a high net worth individual?

B) What portion of the company is being sold at this point

Is it a minority or controlling stake being sold?
Will the buyer(s) have voting rights? 

C) Why the purchase is being made

Are they looking to acquire IP/people/assets, or to protect market share? Is it a case of vertical integration (i.e. a company acquiring its supplier(s)?

D) What stage of the company’s life cycle it is

Is it a potential-filled start-up, a growing business or an established, mature company?

Valuation methods

The above elements will steer a valuation up or down from a baseline range – a range which will have been calculated using one or more of three standard methodologies.

1. Discounted cash flow

Forecasting

2. Comparative

Earnings Multiples

Previous Transactions

Listed Companies

3. Cost

Replacement Cost

Original Cost

1. Discounted Cash Flow

This is the most complex method, and most useful for companies who are a little more mature. It requires preparation of a long term forecast (circa 10-20 years), focussing on cash a business could earn over that period, discounted. The acquirer will likely build their own financial model, using the target’s historic financial data and future businesses assumptions as a base, with their own twist added.

2. Comparative

Earnings Multiples
This is useful for companies in early stages of their life, where there will be limited trading history, limited assets and a great variation in what could happen next. Normally EBIT or EBITDA will be adjusted for exceptional items, and then have an industry standard multiplier applied.

Previous Transactions
If there have been sales of similar companies in the recent past, these can be used to give an indication of the right price.

Listed Companies
For larger more mature companies, comparable companies maybe found listed on stock exchanges.

3. Cost

The cost approaches aim to value a business based purely on the assets it owns/controls. For tangible assets, this can be either what it would cost to replace the assets (i.e. market value) or what was originally paid for the assets. Complexity arrises from intangible assets (i.e. brands, goodwill, licences, concessions, customer lists etc…) as these assets have subjective value.

Why is it important to have an accurate valuation?

In order to get the most accurate business valuation it is important to know why you are going through the valuing processing, and what are you trying to accomplish with it.

An accurate company valuation can enable a company owner to improve their business, bringing four primary benefits:

Better knowledge of company assets

 

An understanding of the company’s resale value


Ability to negotiate more effectively during mergers/acquisitions

Access to a greater number of potential investors

Although many business owners have a vague idea of what their companies are worth, most are guessing over time this guess work can prove costly.  That said, it is extremely difficult for a business owner to create an objective business valuation of their own business.  To ensure an accurate and objective valuation it is always best to use the services of a professional. 

Business valuation relies on the professional judgment of an analyst who will weigh up the nature of the business, its financial performance, local and national economic conditions, values of assets and related liabilities – plus any unique knowhow – before eventually arriving at an estimate of the value of the business. 

Not knowing fair market value could cause owners to sell their businesses for less than they actually are worth – or for heirs to pay more than their fair share of taxes after the owner’s death. For these reasons, the cost of a business valuation can be an excellent investment.

The takeaway

Work out why you need a valuation for your business

Understanding what you need the valuation for will help to shape your approach to the process – and improve your business’ prospects as a result.

Take into account the circumstances surrounding a potential valuation

Your company value will change to a certain extent depending on who is looking to invest in, or acquire, your business.

Work out which valuation method is right for your business

Certain valuation models are great for young companies, while others are better suited to established companies. Pick the one that most closely dovetails with your business.

Don’t expect to get a realistic valuation if you do it yourself

A outside professional will bring a detachment and objectivity to the valuation process that you – being at the coalface – are unlikely to have.

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