Business As We See It March 2016
The Ins and Outs of Valuing a Business
Determining the value of a business is rarely easy. After all, you’ve likely given your heart, soul and energy to build it, so objectively assessing its worth is difficult. Yet an inaccurate valuation can blow the deal when you’re trying to attract buyers. Aim too high, and you’ll scare potential suitors. Come in too low, and you may forgo significant funds.
Fortunately, a business valuation expert can help you arrive at an appropriate value for your company. Here’s a primer on the methods used to value many businesses.
Valuations based on assets
These valuations reflect a tally of the business’s tangible assets, including inventories, plant and equipment, and so forth, as well as intangible assets, such as patents, trademarks and customer lists. Some of these assets can be sold to generate cash if the company fails to perform as expected.
However, this type of valuation isn’t always a reliable way to estimate a business’s future earnings potential, because company-owned assets don’t automatically reveal the money it likely will generate. Instead, asset-based valuations often are used for businesses headed for liquidation.
Valuations based on comparable transactions
Assessing the prices of similar businesses makes intuitive sense: Similar companies should command similar values. However, it can be difficult to find truly comparable businesses. Even two companies that appear similar to outsiders may vary widely in their performance because of differences in, for instance, management expertise or long-term contracts with major customers.
Valuations based on a multiple of earnings
With this method, a business’s value is based on some multiple of its earnings. Many valuation experts tend to place more emphasis on this method, though they’ll factor the other approaches into their analyses as well.
A starting point is to identify a representative earnings number. Many business owners use EBITDA — earnings before interest, taxes, depreciation and amortization — or a similar formula. To calculate the earnings number, they may add back the salary and other benefits currently going to the owner.
Once the earnings number is determined, both buyer and seller must agree on the years to include. Because potential buyers often are most concerned with the future, they may want to see earnings projected at least for a year, and potentially several years.
Although these numbers will, of course, be projections, they need to logically tie back to current performance. Assumptions used to arrive at the projections need to be reasonable. Projections showing a dramatic increase from current sales should be supported with some rationale, such as a new, ongoing and large order or a continuing long-term contract with a significant customer.
The appropriate multiplier can depend on many factors, such as the:
- Industry,
- Perceived risk,
- Reputation of the business,
- Strength of workforce,
- Supply of similar companies available, and
- Types of assets owned by the business.
For instance, businesses with real estate holdings that are easily marketable may command higher prices, as the properties could be sold even if the company doesn’t perform as expected. Conversely, multipliers may decline when the supply of a certain type of business is high — it’s supply and demand in action. A business valuation expert can provide much-needed insight here.
In the end, of course, a business is worth what a buyer at arm’s length is willing and able to pay for it. The approaches outlined here can act as a starting point when determining value. But, often, the valuation process will incorporate multiple approaches — though one may be given more weight than others.
The bottom line
Business owners can set the groundwork for an effective valuation by keeping solid financial records, operating their businesses as best they can, and gaining an understanding of the various methods involved.
Above all, engage a qualified business valuation expert. He or she can bring a solid understanding of the market. But, just as important, a valuation professional will be a disinterested party who can assess your business as most potential buyers will — without emotion overtaking judgment. As a result, he or she can reach a credible, defendable value estimate.
Sidebar: 5 ways to boost your business’s value
There are a variety of ways to increase your company’s value in the eyes of potential buyers. Here are five to consider:
- Organize your records . Sound, properly formatted financial statements, operating reports and customer lists can help boost potential buyers’ confidence in a business.
- Offer to finance part of the sale . Doing so can attract potential buyers who are having trouble obtaining financing on their own.
- Improve assets and reduce liabilities . A turnkey business attracts buyers. Clean physical locations, get rid of obsolete inventory and make sure equipment operates properly. Try to resolve issues that could be seen as increasing risk, such as an outstanding tax audit.
- Show that the company can run without you . It’s harder to attract buyers if the company’s success depends on you.
- Boost sales and earnings . Buyers — not surprisingly — are more interested in companies with solid financials. Tighten your expenses, and look for opportunities to grow revenue.
© 2015
This material is generic in nature. Before relying on the material in any important matter, users should note date of publication and carefully evaluate its accuracy, currency, completeness, and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances.
Share Post:
