Business Valuation

Art or Science?

If a business owner has an exit plan - which every business owner should have -  the primary question on his/her mind is "how much is it worth?"  Unless the entrepreneur wants to leave the business to the children or other family member, the goal should be to sell it and make a profit. Business owners should start thinking about this the day they start the business. But how do business valuations work? Who does them? And what do you need to do ahead of the valuation date to assure your business will sell for top dollar?

Business valuation is an industry within business services. There are firms that specialize in business valuation. They will either represent the owner trying to sell or, sometimes, the buyer who wants to make sure they are paying a fair price. Business valuation is an expertise that takes years to develop. Many of these experts come from the accounting or finance side of business services. So how do they do it?

Business valuation is both an art and a science.  There are many factors that go into developing the value of a business. They fall into two main groups, tangible factors and intangible factors. Each value is weighed based on how it affects the business performance, and what can be expected of the subject business going forward. Remember, a buyer is buying the ability to make money from the existing business.

Tangible factors are easier to value. This is where the science of the valuation takes place.  Tangible factors can be looked up or calculated. They include cash in the bank (if that is part of the deal), accounts receivable (assuming they are collectable) and inventory (assuming it is saleable). Other tangible factors include revenue produced over time, buildings owned by the business that are included in the sale, cash flow, obligations to employees (such as retirement plans, etc). Also included in this value are items that would decrease value such as losses, poor margins, or debt that will be assumed in the transaction.

The discussion of intangible factors is where the art of business valuation becomes part of the equation. These factors include efficiency of the operations systems. Will the buyer have to come in and make an investment in the company to get it running more efficiently? Competition and product will also play a part in the value. If the product or service a company sells is changing due to technology, or is something that is no longer popular to own, the projected sales may be assumed to be decreasing, which would affect the value. Remember the pet rock? The experience of the management team will also affect the value. After the owners of the company depart, does the existing management know how to take the company forward? And, there are factors such as customer base and satisfaction, competition, market share, industry position, vendor relations and location.

So, what's a business owner to do? If the goal is to sell the business (verses leave it to children or family members) you want the value to be as high as possible. Start looking at the business as a buyer would. Assume the buyer wants to buy a business that is running very well and has room to grow. Consult an expert who can guide you regarding the factors you need to be considering.

It is never too early to start to plan for the business valuation. Position your business from the very beginning to meet the high standards needed for a sale and you will be pleased with your valuation when the day comes.

Make it a great week!