To a majority of business owners around the world, the most important business performance metric is the top line or bottom line on their income statements. As long as they can see the former growing moderately Y-o-Y or the latter in the green, they can get a night of peaceful sleep.
I have asked many business owners the market rates of their property, their cars or even the current watch/bag they wear and carry and mostly received an immediate response with a close enough estimate. However, when it comes to asking them the price of their single largest asset, their business, the answers have rarely been certain.
Seldom do business owners spend time and resources to dig in deeper to see the bigger picture for their entities. In the midst of all the ‘business-as-usual,’ they forget asking themselves the main question — “What’s my business worth?”
Why Is This Number Relevant?
The most common question I get from most business owners is this: “Why is a business valuation important if I am not looking to sell my company?” — A fair question, I’d say.
And here is why. A certified business valuation is time-consuming and has a cost. Taking all of these objections into consideration, it’s no surprise that business owners wait until an event requires them to get a valuation performed on their business.
However, it’s important to understand that a life event (e.g, lawsuit, divorce, retirement, downsizing, etc) will probably be the most inconvenient time to get a valuation completed. It’s similar to saying that you’d want to plan for your retirement the day you actually retire.
There are many more reasons that necessitate a business valuation.
An incoming external investment, an internal restructuring, an acquisition or a share swap, separation of partners, a shareholder’s divorce, creation of ESOPs, tax & insurance planning, succession and retirement planning are some to highlight a few.
Every business owner needs to make one or more of the above plans during the business’ running tenure. Wouldn’t it be better to be well-informed rather than being caught by surprise (shock, in most cases) when you are told what this number is at the negotiation table itself? Wouldn’t they perhaps wish they had monitored this value frequently to obtain better, more favorable deals? Wouldn’t they be looking onto their advisor’s side wondering why they weren’t told so?
When Should You Start Valuing Your Business?
This is another common question from business owners. The answer ideally is, right from the very beginning.
No matter which stage one’s business is at, in terms of revenue, product, number of employees, partnerships, branding — this single number has the power to give the owner a sense of direction and motivation to run the extra mile. It enables them to modify their vision for the future, ability to deploy strategies to move to the next level and even hope to keep going when their financial statements aren’t telling them the ideal story.
At the start-up stage, key decisions about operations, sales, marketing, product could each lead to a different valuation in the future. It’s imperative to work bottom up, evaluate future projections and think about valuations, as investors surely will.
For most one-man teams, which have probably moved on from the start-up stage, valuation can be pivotal in matters relating to expansion.
For businesses that have moved onto a team of a few people and have started generating more than just ‘month-to-month existence’ returns, valuation can help the business take on some investment, reinvest its capital sensibly, do an acquisition or structure an incentives program for it’s employees.
And finally, for a successful business with stellar y-o-y performance, a business valuation will help the owner/manager/leader to make informed decisions with any of their shareholders who would often refer back to their financials at this stage.
How Should You Value Your Business?
Every situation, every event in a business would require a different perspective on it’s valuation. For example, if one is looking for an exit, the past and present (equity) should drive the valuation estimate. On the other hand, an external investor would probably want to look at the future and potential of one’s business (enterprise).
Moreover, there are additional questions on the micro and the macro front of one’s business that need to be answered.
At the micro level, owners would need to take a deeper look into their revenue generation, business profitability, stability of cash flow, competitive advantage of the business and reliance of the business on it’s owner.
At the macro level, they would need to dig into the industry lifecycle in which their businesses operate.
In terms of valuation methodologies, there are three widely accepted ones that should be noted:
- The income approach that uses earnings or cash flow bringing them to present value at a discount rate considering the cost of equity and debt.
- The market approach involves an analysis of the recent sale of comparable businesses, as well as value estimates through multiples of financial indicators, generally EBITDA (earnings before interest, taxes, depreciation and amortization)
- The cost approach takes into account the book value and / or market value of the company's assets.
The Benefits?
Knowing the price of one’s business today can help one modify their strategies, so they can reach the optimum level over time and narrate a beautiful valuation story for their business tomorrow.
Now that you know why it is important to be prepared and make a valuation of your company, do not let one of the situations mentioned above surprise you. At Sunbelt Central America we have a structured and comprehensive process, considering both quantitative and qualitative elements of your company; Additionally, we have qualified experts in business valuation. Contact Us!
Source: Entrepreneur