Why is Business Valuation Something You Need to Think About?
What is your business worth? How is it valued? Whether you are thinking of buying a business, selling a business, or planning ahead to sell your business at a future point, knowing what the business is worth is an important first step.
The value of a business is defined as “the price at which the business would change hands between a willing buyer and a willing seller, neither being under a compulsion to buy or to sell and both having reasonable knowledge of all relevant facts.” There is no one formula to get there – the value of any business, including yours, or the one you want to buy, is very complex. The answer to the question “What is my business worth?” has one easy answer – “It depends.” There are as many factors involved in establishing the value of a business as there are reasons to know the value of the business.
Understanding the components that create value in your business can provide you with a framework to increase the value of your business. As an owner, you can use a business valuation as part of your business planning strategy to establish and track goals for your company and to determine the timing of your exit. Your exit might be retirement, or it might be bringing in additional owners that will eventually buy you out completely.
For most business owners, the most important asset they own is their business, but it is the hardest one to place a value on. Investment accounts, real estate, and other assets are relatively easy to value. Business owners may spend a lifetime building their business and working in their business, but have no clear understanding of what it is worth. For many, they imagine it is worth whatever they believe they need to retire comfortably. Reality is often disappointingly less. The sooner an owner understands how a buyer will determine value, the longer the timeframe they have to improve that value and realize success for their years of hard work.
For some business owners, and exit strategy may be bringing in additional owners as the business grows. This can allow for continuity of a business beyond the founder. This is a common practice among professional services companies – accounting, legal, and medical practices – but the concept can be applied in many types of organizations. To successfully set up an ownership structure like this, the business needs to be valued and a method to measure value regularly needs to be established. This can allow ownership to expand and contract over time with ease, and can allow the founder to fully exit when they and the business are ready.
Gaining an understanding of what makes a business valuable to a buyer will help the business owner stay focused on the aspects of their operations that make the most difference in the long term outcomes. Planning on a business sale well before the time they want to sell will enable an owner to get the highest possible value for their business and consider the type of buyer who will place the highest value on their company.
From the buyer’s perspective, knowing how a business is valued will bring you closer to paying “the right price” for an acquisition, not overpaying – so you can see the returns you desire from the acquisition. The asking price and the purchase price are most often not often the same thing. Know that going in and be prepared to negotiate a fair price. Many small business owners have strong emotional attachments to their businesses and tend to consider all their hard work as part of the value. Buyers need to understand that as they work toward completion of an acquisition.
Business valuation is at least partly an art – there is no “one right way” to do it, but there are many sound approaches that have been established over time and through years of practice by valuation professionals. How your business is valued will depend on the size, industry, financial history, and the current marketplace. While there are some “rules of thumb” that can be used to provide a proxy for the value, a complete and professional valuation considers a multitude of factors and comparisons as well as the professional judgment and experience of the individual performing the valuation. A valuation professional has access to multiple sources of data to analyze and compare your business to other similar businesses. They will combine data, analysis, and experience to determine the value of the business.
There are many reasons to have a professional valuation completed on your business, and doing it sooner rather than later can help you plan for the future. While planning will never eliminate risk from business ownership, it will reduce risk, and improve your chances of business and financial success.
Think of all the possible reasons to have your business valued. Which ones are most relevant to you?