The power of knowing the value of your business
May 9, 2019
By Rob Leibfried, CPA, ABV
When I tell someone I specialize in business valuation, the first question I typically get is, “That’s unique, how did you get into that?”
But, they’ll also ask, “So how do you value a business?” My first thought is, “How much time do you have?”
Business valuation can be so much more than a calculation to arrive at a number or a value. If done correctly and used to its fullest, a business valuation has the power to alter the course of an owner’s and a business’ future. This makes it one of the most valuable tools in strategic planning.
What exactly is a business valuation?
The best way to think about a business valuation is as a story for your business. Just like every story is unique, not every valuation is created equal.
A valuation can vary based on the intended user, the scope, the time frame and how “value” is being defined. All those aspects are affected by the facts and circumstances — or the story — surrounding your business.
In some ways, the story of your business is like a biography or a historical account. The business valuation is influenced by past performance of your business, as well as what has the potential to take place in the future.
When it comes to the definition of “value,” it can mean different things depending on the use of the valuation. Typically, it is the fair market value, but investment value also can come into play and can contrast with fair market value because it depends on a specific single investor versus the whole market.
Why do you need a business valuation?
You might need a business valuation for:
- Tax requirements such as estate and gift tax.
- Loan covenants and other bank needs.
- Strategic assessment.
- Buy-sell agreements.
- Succession planning.
- Business health check.
- Exit/retirement income planning.
- Preparation for strategic or unexpected offers to buy from competitors.
Let’s take exit/retirement planning as an example. Assuming your business is your largest asset, wouldn’t you want to know the value so you can properly plan? Many business owners count on their business as their nest egg and part of their retirement income. However, they can be caught off guard when it doesn’t appraise or sell for what they planned.
You know the value of the rest of your retirement assets, so why not your largest?
Let’s cover some myths:
- My competitor sold for $10 million so I must be worth the same. Your competitor’s sale price depends on many facts and circumstances that might not exist in your company. Your company could be worth more or less.
- Financial data alone determines value. Valuation can go far beyond just the numbers. Do you have intellectual property, patents, loyal customers, etc.? These all tell the story of your business that simply slapping multiples on can’t do.
- In my industry, businesses sell for 3 times earnings before interest, taxes, depreciation and amortization (EBITDA), 70% of sales, or some other rule-of-thumb/formula. Rules of thumb are general and do not get into the unique aspects of your business’ value. No two businesses are alike, and even franchises might be substantially different so as to warrant different values. Failing to account for specifics can result in drastically different values. If someone is valuing a business using a rule-of-thumb, proceed with caution.
What’s the value in a business valuation?
Business valuation also is a powerful strategic tool. The valuation process provides key insights into ways to strengthen your business, make it more profitable and understand the dynamics of value. With a business valuation, you get a sharp directional focus so you can understand where you need to make changes in strategy.
You can analyze your strengths and weaknesses compared to competitors, understand their competitive advantage and yours, and use this information to get ahead. All told, this process helps you to transition out of your business the way that you want, potentially exit with a higher value on the sale and have more money in your pocket on the way.
There are other strategic reasons for a business valuation beyond selling:
- Determine what your monetizable assets might be like patents and intellectual property.
- Better understand your internal processes, both helpful and harmful.
- Get a grasp on the marketability of your business. Buyers will want to know that if the owner leaves, the processes will remain and customers will continue to buy.
The power of a business valuation holds mounds of untapped potential for your business.
As a strategic planning exercise, the business valuation process can have a profound impact on your processes and controls, your future business plan and your personal retirement goals.
This article was previously published in the Tri-State Business Times.