A vast majority of business owners associate their business performance metric with their income statements’ bottom line. And as long as that performance metric grows steadily, they assume their business is doing well. They rarely spend time and resources to see and understand the bigger picture of the actual state of business affairs.
So focused on managing their business activities that pay little attention to the actual worth of their business, most owners also wonder why business valuation is necessary or important if they have no plan to sell their businesses that day. This argument serves them well since business valuation is time-consuming, complicated, and expensive. Therefore, they tend to wait until a significant event makes it necessary to get their businesses valued professionally.
The problem? A life event (lawsuit, death, divorce, retirement, business downsizing) is the most inconvenient time to get a business valued.
Business valuation is necessary for any of the following reasons:
- Prospect of a substantial external investment
- Internal business restructuring
- A shareholder’s divorce
- Dissolution of business partnership
- Introduction of ESOPs in the company
- Insurance and tax planning
- Succession planning
- Retirement planning.
As a business owner, you will undoubtedly face one or more of the above situations during your business ownership tenure. A business valuation will help you prepare for any of these situations by ensuring you are well-informed and not caught off-guard. This enables you to make sound decisions, especially under taxing circumstances.
It can be a daunting task to put a price on the time, dedication, and effort you put forth to build your business. Because it isn’t easy to assess the worth of your company after toiling for so many years, it’s best to have business valuations handled by third-party experts.
Understanding Business Valuation
Business valuation is the process of determining an accurate financial value for a company or a particular company unit. The valuation process requires collecting and analyzing a range of metrics, including revenue, profit, and loss statements, business risks, and new market or growth opportunities. A business valuation helps determine the fair market value for several reasons, like finding the sale value, establishing business partnerships, taxation, etc.
The objective is to find the company’s intrinsic value, which helps investors and business owners make an informed sale, purchase, or investment decisions. The three most common valuation approaches are:
- The asset approach: This valuation technique determines the equity value by subtracting the business’s total liabilities from its net asset value or the fair market value of all the business assets. This approach is often used when a company is being liquidated.
- The market approach: The market approach determines the value of the business or an intangible asset by considering the market prices of similar assets or companies that have been sold recently.
- The income approach: The income capitalization approach also divides the property’s capitalization rate by the property’s net operating income. It is utilized to find the fair value of a property.
To learn more about these approaches, read here.
Different approaches measure and identify value in different ways. Moreover, since the market is ever-changing, business conditions also keep changing. All this impacts the buyer’s mindset; as a business’s conditions change favorably, more and more buyers will be keen on acquiring it.
The primary reason for establishing business value is to know what an owner can expect from selling the business. The business value is essentially determined by who wants to see the value and why in the real world.
Valuation Considerations Aside from Numbers
When business owners put dedicated effort into building business value, two factors come into play. Macro factors comprise the economy’s strength and course, availability, cost of acquiring capital, and the regulatory environment external to the business. Micro factors are company-specific, like sales and marketing efforts to grow business revenue, customer relationships, employee management practices, intangibles such as goodwill and intellectual property.
Business value depends on bridging the gap between these critical factors. Since macro factors are outside the business owner’s control, it’s essential to focus on the microelements. A few key factors affecting business valuation include:
Business operation refers to all activities a business engages to earn a profit, build revenue, and increase enterprise value. In an ideal environment, when all these activities are optimized, they bring in enough income to cover all the operational expenses and earn profits for owners.
Business operations are categorized as front-end and back-end operations for a service industry business. To ensure that the company continues to grow and build its value, both the operational sides (front-end and back-end) should run efficiently, as laxity on any one side can obstruct the owner’s overall growth objectives.
Front-end operations include streamlining the delivery of services to clients and customers, ensuring customer satisfaction, receiving feedback (positive and negative), effectively resolving customer complaints, and improving the quality of services offered. Back-end operations relate to hiring the right people, honing their skills with regular training and development programs, eliminating bottlenecks from business processes, and ensuring efficient and timely transfer of knowledge and skills.
A few ways to streamline business operations include:
- Measure business performance
- Stay up-to-date with the latest industry trends
- Streamline processes to improve productivity.
Sales and Marketing
The sales department plays a pivotal role in business success, building loyalty and trust between the business and its customers. To position the business as a leading brand, it is essential to dedicate consistent efforts toward marketing and sales. Customers and clients only acknowledge your business brand, products, and services when strategic efforts are made to market the products and sell them.
Businesses without good marketing strategies struggle to position themselves as brands. They are unaware of their competitors’ strengths and, as a result, have dwindling sales.
A few ways to increase marketing outreach and business sales include:
- A clear understanding of the target audience. Businesses struggle to sell their products when they do not clearly understand their target audience and their needs. A target audience profile is essential to building the marketing plan and executing it. For example, a business that manufactures running shoes is better served by placing an advertisement in a sports magazine than in home décor or lifestyle magazine.
- Build content. Good content provides valuable information about the product and effectively grabs the target audience’s attention, especially in digital marketing.
- Maintain an online presence. Social media (Facebook, LinkedIn, Instagram, Twitter, etc.) have become one-stop shops where customers can easily interact with the brand, buy products, and leave reviews. Businesses can steadily increase their client base by staying active and consistent on social media.
Business owners juggle multiple aspects of their companies: they manage the budget, sources of revenue, marketing efforts, products, employees, and company culture. In this mayhem of management, culture often takes a back seat.
Failing to prioritize company culture may lead to severe consequences, such as what happened at Uber. Although all-new Uber employees are expected to practice the core company values, there is an emphasis on “meritocracy,” the idea that the best will rise to the top, no matter the circumstances, even if it means stepping on others’ toes to get there. Unfortunately, the company’s focus on pushing for the best results has led to “what the current and former employees describe as a Hobbesian environment in the company. Employees are pitted against others, and often, a blind eye is turned to contravention from its top performers.”
Positive company culture means putting employees first and engaging them in the workplace. Engaged employees have a deep connection with other employees across the company. They work for a greater purpose and strive to find meaning in their work. Such employees also work well within their teams, have positive relations with other colleagues, and are always motivated to contribute more toward its success.
Dependency on Key People
Business owners often rely on themselves or a few key people for business operations without realizing that this overreliance may leave a gaping hole in their companies should those people leave.
This dependency on a few individuals is terrible for productivity and profit and has a stifling effect on the growth of other employees. Moreover, planned or not, their departure can jeopardize the business’s ability to deliver services on time and damage the company’s market reputation.
Owners may find themselves at a loss when dealing with a key person unexpectedly resigning, retiring, or coping with a long-term illness. That employee’s absence significantly impacts daily operation because there is no one else to pick the slack. As a result, companies with high dependency on a few key individuals are considered high risk. That has an impact on the business value.
Focus on What’s Important
Ultimately, recognizing and assessing these critical valuation factors will help you focus on areas in your business that need improvement. Since these factors determine the growth, sustainability, and value of a business, business owners should put in the much-needed effort and focus on overcoming challenges in those areas.