How Much Is Your Business Worth? What You Should Know About Business Valuation
As a valuation professional, I often find business owners imagine their business is worth more than it likely is. They have worked hard their whole lives to build their business and have seen it through both the good and challenging times. When they are ready to exit and discover that their business is worth less than expected, it is quite disappointing. As business advisors, we encourage our clients to understand the inputs that affect their business' value and develop ways to increase the value.
That is where a business valuation expert comes in. When a business owner hires a valuation professional when they are ready to sell their asset, it is often too late and can result in a less than satisfactory sales price. Engaging a valuation professional five to seven years out will pay dividends. The professional can work as a consultant to determine the company's current value and inform the business owner what opportunities exist to increase the value.
Determining the Current Value of Your Business
There are several considerations in the business valuation method that determines the business' current value. Business appraisers start by performing financial analysis and evaluating the company's financial and operating results and statistics. Methods of valuation also include:
- Earnings Before Taxes, Interest, Depreciation, and Amortization (EBTIDA)
- Cash flow, both historical and projected
- Seller's discretionary earnings
- Assets and liabilities
- Major customers and vendors
- Current management
- Reliance on ownership and other key employees
- Geographical location and customer/client base
- The national, regional, and local economies the company operates in
- Industry forecasts
Under the income approach of valuing the business, the valuation expert will often "capitalize earnings." This involves developing a "benefit stream" and dividing it by the company's risk rate. The benefit stream is usually a form of the company's normalized net cash flow. The risk rate is commonly determined using the "build-up method." This starts with the risk-free rate (usually the 20-year rate of a treasury bond) and adding premiums for equity, size, and industry risk.
Using the market approach, the valuation professional will perform a comparative analysis, searching databases for comparable businesses that have sold that are similar in size to the subject company. Analyzing the sales price divided by the annual revenue and the sales price divided by the seller's discretionary earnings, the valuation analyst will then develop a multiple to apply to the subject company to determine the value.
Common Issues that Impact Business Valuations
After the analysis, the valuation professional will present the current value and what it could likely be worth based on what the market has yielded. Most of the conversation will focus on the areas that are currently negatively impacting the company's value, and how those areas may be improved. Listed below are some of the more common issues that we run into during a business valuation:
1. Reliance on ownership and key employees
Frequently, the business owner is a key person in the day-to-day operations of a company. Not many know the business quite as well as they do. The problem is, someone wants to buy the business, not the owner. While an owner may offer to stay on for a few years after the sale, this will drastically increase the business's risk and negatively impact the value. The key to solving this is to develop a solid management team that reduces the reliance on one or two key people.
2. Reliance on major customers
This is a significant risk for companies that depend on a few large customers. To increase value, revenues should be diversified. This is also true for companies that depend too heavily on one industry.
3. High employee turnover
This is becoming a growing issue that has affected many industries. These days it's hard to find good people, and when a good employee is hired, time and money are invested in that person. High turnover leads to low productivity, increased labor, overtime costs, and time and money to train replacements. A higher than industry turnover rate will increase the risk and lower the company value.
4. Lack of investment in the company
This area is also becoming a growing issue as the technology in most industries is rapidly changing. To stay competitive and increase productivity, companies need to invest in technology, machinery, and equipment.
Whittlesey encourages business owners to think strategically about their exit strategy, usually five to seven years before selling your business, by building a team of valuation professionals to help get owners where they want to be when the sale does occur. Valuation experts play a critical role in the team and can help in the planning process to ensure that measures are taken to maximize its value.
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