Whether you are still working on a business plan for your start-up or have been running your company for decades, you like most entrepreneurs probably have a dollar value in mind at which point you plan to sell your business. Isn’t that one of the main reasons why we take the risk of starting our own business – to eventually sell it for big bucks?
But, before you put a down payment on that new yacht or buy that vacation home on a far away island, be sure you have a firm understanding on how your company will be valued by the marketplace. The value you place on your business may not be what the market values it at, and that may leave your checking account a bit lighter than you expected. However, understanding the value of your company today will enable you to make adjustments in your business plan to ensure you hit your valuation number when you are ready to sell to the highest bidder.
Valuing a business is always an imprecise science, even with large-cap public companies. For example – Is the value of a large public company based on its market price? It’s book value? It’s potential worth if broken into parts that have more perceived value than the whole? The answer is that there are many ways to determine the value of a company.
Perhaps the best way to understand the “value” of any business, large or small, is to look at who’s doing the valuing and for what purpose. For example, we’ll wager that you would value your family business differently for estate purposes versus a sale of the business.
Regardless of how a business is valued, there are both quantitative and qualitative factors that play a role in a comprehensive appraisal. Many of the elements that go into a business valuation can be classified in three categories:
- “Hard numbers” such as historical profits, assets, cash flow and liabilities are always important in determining the worth of a business.
- “Soft figures” such as income and cash flow projections can be very important to a buyer or investor interested in the company
- “Intangible assets” such as patents, brands, quality or reputation of management, location, recipes, processes, technology, customer lists or goodwill often have a hand in determining the overall value of a business.
There are many reasons to value a business, and “the reason” for the valuation is typically an important factor in deciding how an appraisal will be performed. This is why in many instances, more than one value can be correct.
As indicated above, two of the more common reasons to value a company are for a sale or for estate tax purposes. Other purposes for performing a valuation might include acquiring insurance coverage of various types, attracting an angel or venture capital investor or seeking a credit facility from a bank or finance company. The key considerations that go into any valuation include:
- Company, competitor and industry information. How is your business performing and how does it compare to your competitors? What is the state of your industry? Is your business in a growth industry or a declining one?
- Analysis of historical financial statements. Ratio analysis such as return on equity or gross margin is often helpful.
- Projected financial statements going out three to five years can be particularly significant, especially if they are recast to reflect the business without owner compensation. By recasting statements, the value can be estimated as if the business were under different ownership or managed under different circumstances.
- Using a method of valuation that is appropriate for the purpose of the valuation.
To Be Continued . . .
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