Understanding Valuation – Determining the Worth of Your Business

I. Introduction

A. Importance of Business Valuation

Worth of Your Business

Determining business value is a very crucial stage for owners and managing officers. If you’re considering to how to sell a business, the first step is to get your business valued.  An independent third-party business valuation will estimate the total company’s worth in a sale process. These baseline valuation calculations are beneficial for several reasons, such as raising capital for an investment, assessing the need for restructuring, preparing to make acquisitions/divestitures, deciding on buyouts of partners, and selling the business via an M&A advisor or business broker. The valuation process can also help owners understand the key valuation drivers in their industry and for their business size.  These can help owners decide if they wish to implement an exit plan to increase the business’s future value when they are ready to exit.

B. Overview of What Will Be Covered in this Blog

This article will offer a holistic view of the business valuation concept, explanations of different valuation methodologies, importance of value drivers to an enterprise, best-practices for valuation accuracy, reasons to involve valuation experts, and real-life applications.

II. The Basics of Business Valuation

A. Definition of Business Valuation

Valuation of business is the combined processes of analyzing multiple facets of a business including financial performance (past and future), assets, earnings predictability, growth opportunities, and many other commercial characteristics. Prime reasons for valuation include preparation for sale, estate or tax planning, investor presentations, ownership disputes, and corporate litigation.

B. Different Methods of Valuation

There are three main approaches to valuations:

  • Asset-based valuations consider asset fair market values.
  • Income-based valuations analyze past and estimate future earning capacity.
  • Market-based valuations compare actual sale transactions of similar companies.

C. Factors Influencing Valuation

While based on financials, valuations also involve qualitative judgments around growth outlooks, risks, buyer dynamics, customer concentration, income predictability, owner involvement, and competitive forces. As such, valuations are both art and science.

III. Asset-Based Valuation

A. Explanation of Asset-Based Valuation Approach

A balance sheet approach to business valuation considers the asset value less debt. The sum of item that can be touched like land, stock, and equipment and can also include intangible assets like brands, intellectual property, and goodwill.

B. Types of Assets Considered in Valuation

Tangible assets include property, plants, equipment (collectively PPE), inventory, and other physical items. Intangible assets include copyrights, patents, brands, processes, databases, contracts, and goodwill. Some assets, like major pieces of machinery, may require specialized equipment appraisals.

Intangible assets include copyrights, patents, brands, processes, databases, contracts, and goodwill. Intangible assets are the property which is not easily seen with an eye.

C. Pros and Cons of Asset-Based Valuation

Upsides to asset methods include straightforwardness and lower appraisal costs. However, asset approaches often miss earning upside by ignoring cash flow history and growth trends, making them best as minimum valuation indicators.

IV. Income-Based Valuation

A. Explanation of Income-Based Valuation Approach

Income approaches value a business by analyzing its ability to generate economic benefits, like cash flows and profits, over time. Two widely used methods include discounted cash flow (DCF) and capitalizing sustainable earnings.

B. Calculation Methods

DCF models project future expected free cash flows, which then get discounted to present day value based on current cost of capital and business risk profiles. Capitalization methods apply industry-standard valuation multiples against historical and forward earnings estimates.

C. Importance of Financial Statements

Income methods rely heavily on historical and projected financial statements, like revenue growth, profitability, capital spending, debts, and working capital metrics. Normalizing one-time non-recurring incomes or expenses facilitates apples-to-apples comparisons.

V. Market-Based Valuation

A. Explanation of Market-Based Valuation Approach

Market-based approaches benchmark a target company’s performance and multiples against completed transactions and trading comparables of similar public or private peer firms. Sources for industry valuation benchmarks include deal databases, exchange filings, and proprietary closed business sales data.

B. Comparable Transactions Method and Application

This relative valuation method applies market-derived ratios, like enterprise value compared to EBITDA, price per earnings, price per sales, etc., based on empirical observations from recent deals involving comparable firms. Multiples get adjusted for size, growth, margins, risk differentials, and other appropriate factors. Larger businesses can use public companies to provide listed reporting company deal data.

C. Challenges in Finding Comparable Businesses

Identifying very similar comparables can prove challenging. This method is most suitable for typical companies in mature industries. Startups and distressed businesses often lack comparable data from peer sales. Normalizing performance differences between benchmark and subject companies can also pose difficulties in applying market multiples accurately.

VI. Factors Influencing Worth of Your Business

A. Industry Factors Affecting Valuation

Industry maturity, growth rates, fragmentation, competitive dynamics, regulation, and technological disruption influence valuation ranges. Macro trends like globalization, power shifts among Buyers and suppliers, and sustainability concerns also impact valuations by industry.

B. Financial Performance Metrics Impacting Valuation

Higher valuations are the reward when the business’ metrics signaling growth potential and cash generation capacity over accounting profits. Key indicators include revenue growth, profitability margins, cash generation, working capital performance, capital efficiency, and sustainable competitive advantages.

C. External Factors

External factors like ease of getting capital, broader economy, industrial policies, trade policies, government regulation, and M&A landscape influence investment capacity. Business negotiation leverage also impacts transaction pricing.

VII. Importance of Professional Assistance for Determining Worth of your Business

A. Role of Business Valuation Experts

Engaging professional valuators provides an independent, objective perspective. Experts also facilitate accuracy via access to proprietary data and frequently performing valuations. Leading experts will also have special understanding and knowledge of your industry.

B. Benefits of Seeking Professional Valuation Assistance

Experts determine reasonable estimates grounded in expertise and data. They identify value drivers while normalizing exceptions. Documentation also supports conclusions for investors and stakeholders.

C. Tips for Selecting a Reputable Valuation Firm

Look for specialists matching your business size, industry, sectors, and situation. Check credentials, experience levels, and extensive client reviews. Ensure transparent assumptions and methodologies, plus, of course, the ability to maintain confidentiality.

VIII. Conclusion

A. Summary of Key Points

Business valuation blends quantitative inputs and qualitative judgments of future performance. Valuations serve many strategic purposes, both finance and non-finance, for owners and leadership. Accuracy requires vigilance to avoid underselling or overstating your business’ accurate worth.

B. Final Thoughts on How to Sell a Business Quickly with an Accurate Business Valuation

Valuations provide important factual data during key events in a company’s journey. Applying industry-based rigor, while engaging subject matter experts, helps owners make optimal decisions when selling their business, including price, terms. and deal structure.  Correctly pricing the business will attract serious, motivated purchasers with capital who will compete for the business. By following these guidelines, you will be well-positioned for purchaser when you have already considered all the questions to ask when buying a business BEFORE you go to market.  Read about how to find the right strategic buyer for your business.

Business valuations serve many essential functions, from raising capital to planning exits. However, deriving an accurate estimate of worth of your business requires expertise spanning both understanding the numbers and interpreting qualitative factors. If buying, selling, or strategically growing your company involves determining its economic value, leverage the industry-specific experience from the professionals at Adam Noble Group. For 3 decades, we have been guiding business owners and their families CONFIDENTIALLY to exit their business with the BIGGEST paycheck of their life!  Contact us now.