It is often said that estimating the fair market value of a business is part art and part science. This is because business valuations are completed in a notional or “theoretical” context. The only way value can be determined with absolute certainty is to expose the business for sale in the open market and complete a transaction.
But how do you price your business, determine the asking price or the value of shares for investment purposes? You need a business valuation to set the peg or the anchor; a starting point for the negotiations.
The Art of Business Valuation
The qualitative analysis of the business drives the art portion of business valuations, it’s the risk profile of the business and the non-financial aspects of the business that make it attractive to a prospective buyer or an investor.
Some of the factors that can contribute or detract from the value of a business are:
is the industry improving or declining
how is the business correlated to the economy as a whole
is the business seasonal or cyclical
how may hours per week does the owner work and what are his or her duties
does the business have reliable, tenured staff, what is the turnover rate
is the business dependent upon one or two key employees;
is the customer base diversified or concentrated;
is the customer base loyal or not, nature of repeat sales
is the business operating at or near capacity
is the business capital intensive or technology driven
what is the nature of the competitive environment
is the business well established and known, its brand
The Science of Business Valuation
The science of business valuation is primarily based on an analysis of the financial position of the business, and its past financial performance. In essence, “How much can a prospective buyer/investor afford to pay for this business?”
Some of the quantitative factors that affect the outcome of this analysis are:
are the financial trends of the particular business increasing or decreasing;
does the business have a solid financial track record for three to five years;
what is the level of debt, is the business heavily leveraged or not
are there any significant anticipated capital costs
are the expenses expected to remain stable or increase
does the business provide sufficient discretionary earnings to the owner
does the business meet the criteria needed to obtain financing
how do the business performance indicators compare to its peers
Many small business owners operate their businesses to suit their lifestyle needs as opposed to maximizing business value. They do not prepare the business for sale and they operated as if they are never going to, or need to sell. Michael Gerber sums it up in the e-Myth, “...the only reason to own a business is to sell the business.” Every business is ultimately going to either be sold or it is going to close its doors. As life goes, unexpected circumstances arise and owners find themselves in situations where they need to sell their business or take on a partner unexpectedly for one reason or another. In many cases, it is for health reasons or other circumstances beyond the owner’s control. The result is the business is sold for far less than its potential value or the business never sells at all and is liquidated.
BE PREPARED! Start early, well before you need to sell or take on a partner/investor. Get the house in order, as with selling or renting a home, you need to stage your business; show it in the best possible light, this includes:
Financials statements (min 5 years)
Forecasts for at least 12-24 months
Obtain a business valuation from a qualified business valuator
Clean up the balance sheet
Update the Business Plan
Develop a Marketing Plan
Develop a Operational Manuals
Update the employee manual – job descriptions for key staff
Organize the business to make it as valuable as possible to others by demonstrating how the business can function and continue to generate cash-flow without you. With proper planning, a business owner can not only increase the value of their business but can also turn what would typically be considered to be an illiquid asset into a fairly liquid one.
To get your early valuation and strategies to maximize your business value, call or send us an e-mail today.
Malahat Valuation Group