Business Valuation
If you are planning to sell your business, it’s clearly an advantage to have an objective valuation of what your business is worth. A valuation should ensure that all the hard work you have put into the business will be taken into account and included in the price.
However, a valuation can be important at other times as well. It can be useful if you are seeking investment capital, taking on a partner, or selling shares. A valuation can also indicate how you compare to your direct competitors. It can identify the strengths and weaknesses of your business. When a valuation identifies weaknesses, it can help you focus on building long-term value into your business. This will improve your outlook in terms of succession and estate planning.
However, many companies are oddly reluctant to invest in getting an accurate valuation. Only 29 percent of fast-growing companies have a current business valuation, according to a survey reported by CFO.com. A further nine percent are planning to get a valuation in the next 12 months, while 15 percent have a valuation that is no longer current. Forty-four percent of the companies had either no valuation or no plans to get one.
The survey also found that 25 percent of the CEOs had tried to sell their business at some time, but only 48 percent of that number had ever had a formal valuation. This is surprising. If you approach a major financial decision without having an effective valuation, you are in some respects flying blind.
Beware that a formal business valuation will not give you a single pound figure that will be an effective guide to the value of your business in all circumstances. There are many different valuation methods and, unfortunately, each method is likely to yield a different pound result.
Different methods may be appropriate for different businesses. For example, if you run a services business, there’s little point in evaluating your business based on the value of its physical assets. Other methods consider intangibles such as ‘goodwill’, which are difficult to evaluate. And value may also vary with context and subjectivity—a business may be worth different amounts to different people, depending on their preferences and needs.
The valuation may include carrying out ratio analysis of these figures - for example, by calculating return on equity or investment.
Other factors are not so cut-and-dried. Valuation might focus on financial projections for the next three to five years. It might consider intangible assets, such as intellectual property. Do you own any patents, for example? Can you put a value on your trademarks and brand names? What is the value of goodwill to your business? How much has good management contributed to the value of your business, and will good management continue to do so into the future (particularly in your absence)? You also need to consider the context. Your company may be doing very well, but its value will be diminished if it is part of an industry that is in serious difficulty or in decline.
There are over a dozen different valuation methods. The crudest method operates by rules-of-thumb or ‘multiples’. For example, a legal firm is commonly valued at 40 to 100 percent of its annual fees, with consideration for an ‘earn out’ period, according to Entrepreneur.com. Landscape businesses are estimated to be worth one to 1.5 times their discretionary earnings, plus the value of their capital assets. However, multiples only give a rough, industry-wide ballpark figure for business value. They do not necessarily give the exact value of any particular business.
More accurate methods include the ‘balance sheet’ approach, which basically subtracts business liabilities from assets. The ‘adjusted book value’ method is similar, but uses current market value rather than purchase price or depreciated value.
Retail and manufacturing businesses are often value assessed according to the value of their assets, given that they tend to store large amounts of value in their inventory or capital assets.
Service companies are often valued through the ‘capitalisation of income valuation’ method, which places a heavy emphasis on intangible assets. It’s also possible to calculate the value of a private company by making a comparison with an equivalent public company and making appropriate adjustments. Business value can also be estimated by anticipating cash flow over a three to five year period, and adjusting that into current pound terms.
Aside from the rule-of-thumb approach, these approaches have one thing in common: they are not simple. Business valuation tends to rely on sophisticated financial calculations, good judgement on likely prospects for a business, and an astute assessment of a variety of intangible factors.
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