How Do You Value A Business?
Business valuations are one of the toughest challenges business owners face. Since the majority of owners only own one business in their professional lives, many don’t have the experience or expertise needed to arrive at an accurate valuation. And since most of your net worth is tied up in one asset, having an accurate idea of its worth is critical.
Here are the three big-picture steps to give you an idea of how to value a business.
1. Align your expectations.
Learning how to value a business is important because you need to make sure you have suitable expectations before beginning.
First, understand that there is no magic formula that can determine the appropriate value of all businesses.
Not only do M&A professionals say this, but the IRS does as well in Ruling 59-60 :
“No formula can be devised that will be generally applicable to the multitude of different valuation issues … A sound valuation will be based upon all the-relevant facts, but the elements of common sense, informed judgment and reasonableness must enter into the process of weighing those facts and determining their aggregate significance.”
You also shouldn’t expect to be able to determine your company’s worth in a few minutes.
Often in an initial meeting, many business owners ask M&A professionals to give an estimate, or ballpark number, of what they think the business is worth. When this happens, professional M&A advisors will politely point out that they cannot do so without a business valuation (Step #2).
Anyone that provides you with a number before conducting in-depth analysis of your business should be avoided.
Even though you may want immediate answers, learning these things up front will help the business valuation process go smoother. Moving on to the next step in how to value a business…
2. Complete a thorough evaluation.
To get an accurate business valuation, you must first start with an exhaustive review of your business. The evaluation includes a close look at the company’s products and services, looking for those features that make the company successful.
You also will want to break down your customer base and analyze what percentage is responsible for the most revenue, what motivates customers to buy the company’s products and services, how long have they been customers, how
they were acquired, etc.
This is often where business owners need outside help, and they hire an M&A advisory firm. Because owners are so close to their companies, oftentimes they don’t recognize what truly makes them unique.
Recasting is another reason owners hire M&A advisors. Any business owner that is contemplating selling a company needs to have their financials recast.
Recasting is the accepted accounting principle of removing or adjusting items on your financial statements that are unrelated to the ongoing business. Things like excessive or discretionary expenses are examples of items that can be removed or adjusted during recasting.
Adjusting financials is a necessary part of this process because you then will use the recast numbers to project financials for the current year and five years out. These projections need to be accurate because buyers are buying your company’s future. not the past.
For a complete discussion on the evaluation and recasting, click here .
3. Use a variety of valuation methods, mixing art and science.
The last step in how to value a business involves reaching that end number.
Here are several common valuation methods:
- Public market comparable analysis
- Identifying precedent M&A transactions
- Discounted cash flow analysis
- Book- or asset-based valuations
- Applying multiples to revenue, EBITDA, or net income
- Accepted industry “rules of thumb”
In most cases, a person’s M&A advisors will determine how to value a business using the best combination of methods for the company at hand. Sometimes formulas can provide good estimates, but using one formula alone is risky, as it will not factor in your company’s unique qualities. In reality you need to analyze all methods when determining the value of a company.
M&A professionals use their experience plus their extensive financial knowledge and analysis of your business to determine an optimal value for your company.
Learn More About How To Value A Business
Hopefully this gives you more insight into how to value a business.
If you want to learn more, we have crafted a complimentary whitepaper entitled Selling A Business – Part I: The Evaluation that goes more in-depth. Just follow the link to download it .
Carl Doerksen is the Director of Corporate Development at Generational Equity.
© 2013 Generational Equity, LLC All Rights Reserved
Category: Personal Finance