How to Determine Your Company’s True Value
Business owners often rely on their gut estimates when calculating the value of their companies. Their attachment to the business usually makes them overestimate that value. A value with no basis in complex data cannot form the basis for a long-term strategic business plan or an exit plan.
Hire expert business valuation advisors to calculate the actual value of your company. Getting a professional business valuation will help you determine your business’s current market value (CMV).
Business Valuation Benefits
Reliability. A business valuation provides stakeholders of private companies with a reliable estimate of business value. Valuing a privately-held business is often tougher as its equity does not trade on the stock exchange.
Credibility. A certified valuation lends credibility to both the buyer and the business seller. As analysts follow industry guidelines and standard procedures to conduct the business valuation process, the result is accurate and acceptable to all parties involved.
Legal acceptance. A certified valuation is acceptable in the court of law if a legal dispute arises. The judge permits a business value determined by the analyst to serve as evidence in court.
Tax issues. A business valuation is required to accurately estimate different taxes, such as estate tax, gift tax, etc. For example, a business valuation helps file the estate tax return when a business owner passes away. Similarly, when a business owner gifts shares, the CPA needs a business valuation to calculate the gift tax liability arising from this transaction. A certified business valuation serves as a defendable document if an audit occurs on the estate tax return or the gift tax return.
Industry worth. When you get a business valuation, the analysts consider the particular factors of your industry while determining the enterprise value. For example, the value of your business assets that help increase productivity and give a competitive advantage could be more than the book value listed in your books of accounts. Therefore, prospective buyers will be willing to pay far more than the book value for such assets.
Intellectual property worth. Professional business valuation analysts also assess and document the value of your company’s intellectual property. Such analysis requires experience and industry knowledge. In the event of a business ownership transition, both the buyer and the seller are more likely to agree to the IP value mentioned in a certified valuation.
Facilitation of buy/sell agreements. A buy/sell agreement is a legal contract that stipulates how the company will reassign the shares/interests of a departing business partner. Usually, when a partner decides to exit, business valuation is used to determine the sale price of the partner’s interest in the company. It also helps decide on the process in advance with the help of a buy/sell agreement so that the potential transaction between the partners becomes easy.
What Factors Help Determine Your CMV?
Financials
The analysts performing the business valuation will request your company’s financial documents and use them in the process. These documents may include agreements, contracts, tax statements, cash flow statements, insurance, or other forms of financial documentation.
EBITDA Size. EBITDA (earnings before interest and taxes) is one of the standard measurements for determining business value. It measures the operational profitability and general cash flow of the company. The EBITDA multiples of different industries vary wildly. Also, large companies command higher EBITDA multiples.
Revenue trends. Flat, substandard, or decreasing revenue growth garners an average or lower market multiple. Consistently high, historical, and prospective revenue growth commands a premium to the prevailing market EBITDA multiple in the industry. Also, recurring revenue growth is more valuation than revenue spike due to a one-time project.
Profit margins. High-profit margins indicate that the company has a competitive advantage through unique offerings, production capabilities, or distribution channels. They attract higher EBITDA multiples and command valuation premiums.
Operations
Another area the analyst will assess is the company’s operations. Such as how involved the founder is, the marketing of the company, or any other business operations.
Customer concentration. Customer concentration significantly impacts business value. A company where a single customer brings over 20 percent of total sales or three customers that generate more than 50 percent of annual sales has high customer concentration. That leads to the company attracting lower-than-average EBITDA multiples compared to its industry peers showing equivalent revenues and profitability but a more diverse customer base. A company with high customer concentration can remedy the situation by entering into long-term contracts with large customers. It will show a stable income.
Industry concentration. Companies operating in industries growing faster than GDP (gross domestic product) attract higher EBITDA multiples or command valuation premiums. However, businesses having a seasonal or cyclical nature or concentrating within a particular end market are more vulnerable to variables such as regulation changes, increased competition, disruptive technologies, etc. Such companies are likely to get lower than average EBITDA multiples in the industry.
Management team’s strength. Small business owners usually take responsibility for multiple key functions, making their companies overly dependent on them. That dependence is necessary during the early stages of the business. Still, your company’s continued reliance on you raises a red flag in terms of value because reliance on one person to run the business increases risk. All else being equal, a company with a solid management team of talented people leading different essential functions is more likely to attract a premium valuation and high EBITDA multiple.
Competitive advantages. A sustainable, competitive advantage reduces risk and increases growth potential by protecting itself from the competition. The market rewards a company with a premium value and a higher EBITDA multiple. On the other hand, a company vulnerable to competition gets a lower EBITDA multiple.
Key Takeaways
Hire professional valuation experts to carry out a business valuation and determine the actual value of your company. Not just necessary when you are planning an exit, business valuation also helps draft your company’s long-term growth strategy.
A business valuation takes many factors into account before determining your enterprise value. It reveals the true worth of your business if you were to take it to the market today. Get in touch today to learn more.
