“What is my business worth?”
That’s one I get a lot… “Give me a rough idea – back of the envelope.”
And as an old mentor of mine known as ‘Dr. Value’ would say: “It Depends.”
Most people don’t wake up one morning and think: “I wonder what my business is really worth?”
Ok, some do. But then they usually lose that enthusiasm at the notion that they might need to spend a few bucks to get the answer.
The reality is that a valuation is typically performed because someone else will tell you that you need to have a valuation performed.
It’s usually in order for you to complete some other task – the real objective if you will.
Here are just some of the reasons that might trigger the need for a business valuation:
Objective #1: You’re trying to incentivize your key employees with stock-based compensation.
- Your accountant advises that you need to have something called a 409A valuation done.
Objective #2: You’re trying to gift shares of your business to your children or grandchildren.
- Your attorney advises you that you need a valuation to satisfy the requirements of the IRS.
Objective #3: You’re trying to raise capital either through private equity or a public offering.
- You’re told by both your accountant and your attorney that you need to have those stock options valued.
How to Value The Business
There are several methods used to value a business: the Income Approach, the Market Approach, and the Asset-Based Approach.
- Income Approach: Value is derived by discounting future cash flows available for distribution to present value at an appropriate rate of return. The Income Approach represents a quantification of the future dividend paying capacity of the business.
- Market Approach: Value is derived by analysis of the prices at which shares of capital stock of reasonably comparable companies are trading in the public market, or the transaction price at which similar companies have been bought or sold. This approach includes an analysis of any past sales of ownership interests in the business being appraised.
- Asset-Based Approach: Value is derived by analysis of the individual assets and liabilities comprising the business. In this approach, the tangible and intangible assets of the business are individually appraised using the various Approaches. The Asset-Based Approach involves estimation of the current reproduction cost of the asset, less an estimate of accrued depreciation to reflect physical, functional, and economic obsolescence.
The Asset Approach is best for asset-intensive business or companies facing liquidation. For most operating companies, there are two key fundamental ways to think about the value of your business:
- Valuation is forward-looking. The value of your business is equal to the present value of the future monetary benefits it can deliver. (Income Approach)
- The value of your business is equal to what someone else is willing to pay for it. (Market Approach)
Naturally, the only way to know for certain what someone is willing to pay for the business is to put it on the market, but knowing how similar businesses transact will give you the knowledge to make data-driven, informed decisions.
If you’re not familiar with these valuation techniques and you’d like to learn a little more, you might enjoy taking a peek into these methods from the perspective of the TV show Shark Tank.
Why It ‘Depends’
The value of your business (or business interest) depends on what exactly needs to be valued, why it needs to be valued, when it needs to be valued and for whom it needs to be valued.
A few things to consider:
1. Is there debt on the balance sheet? If the answer is ‘yes,’ the value of your business depends on how much. As an every day example, if your house could be sold for $300,000 today but you have a mortgage (debt) of $200,000, your equity interest is only worth $100,000. The same is true for the business.
2. Is your valuation as of a recent date or do you need to go back in time to say, the date of someone’s passing for an estate matter? Markets and valuations change over time.
3. If your needs pertain to a minority ownership interest in the business, understand that it will generally be worth less than a controlling interest in the business because thre is value associated with the prerogatives of control.
4. The value of the minority interest also depends on what other classes of equity have preference ahead of it.
5. Furthermore, if that ownership interest is illiquid, understand that it will be worth less than if it were traded on an exchange or otherwise lacked the restrictions on liquidity.
6. Using the “back of the envelope” to value a business with a rule of thumb is not the solution. There is no Silver Bullet of Business Valuation.
** Bonus Tip For Business Owners **
Have you been running the business with a strategic goal of trying to minimize your tax payments? If so, that means that your financial statements probably show that you aren’t really all that profitable.
Saying it that way has a different feel about it, especially from a potential buyer’s perspective, doesn’t it?
NOT.
REALLY.
PROFITABLE.
And what value might a not-really-profitable business have?
Five times zero is still zero.
If a sale or other liquidity event might be on the horizon, you probably should discuss this point with your advisers fairly soon.
So if you do wake up one morning wondering “what is my business worth?,” remember that “It Depends.”
About the Author:
Dave Bookbinder is Executive Director of Valuation Services at Haefele Flanagan. Dave is known as an expert in business valuation and the person that business owners and entrepreneurs reach out to when they need to know what their most important assets are worth. Known as a collaborative adviser, Dave has served thousands of client companies of all sizes and industries.
Working closely with business owners, CFOs, Controllers, and CEOs, Dave strives to build relationships that add value for the long term. Dave is also the host of Behind The Numbers, the business talk show that digs deeper to understand what matters in business. Available wherever you get your podcasts.
If you believe that people are a company’s most valuable asset, and want to learn more about the impact that people really have on the value of a business enterprise, you might like the Amazon #1 best-selling books, The NEW ROI: Return on Individuals (white cover), and The NEW ROI: Going Behind The Numbers (black cover).
Dave’s latest book, A Valuation Toolbox for Business Owners and Their Advisors demystifies valuation methods and sheds light on common mistakes, and was recognized as a top new release in Business, Mergers & Valuation.
For future insights and articles, connect with Dave on LinkedIn, like him on Facebook, follow him on Twitter / X. Please visit www.NewROI.com to learn more and be sure to check out Dave’s thought leadership at CFO University. While you’re here, you might also enjoy some of Dave’s other articles.
Views and comments are always my own.