How to value a company
This section is devoted to the crucial first step to take before selling your company – how to determine the value of a business.
How is it possible to sell a business if you don’t know how much it’s worth? That is one of the first lightbulb moments you should have while preparing your exit strategy.
You should have a good estimate of your company’s value before you even decide the time is right to go to market – if not, you’ll be left hoping that your current valuation is in line with what you need for the next stage of your journey.
How much is my business worth?
In truth, the answer to this question is fairly straightforward:
The value of any business is what a willing and informed buyer will pay for it!
Of course, the process of determining a company’s value is a bit more complex. It depends on the strength of the buyer’s market right now, the appeal of your industry, its recent and historical financials, the value of its intangibles and more.
Ultimately, all of these factors will result in different values from buyer to buyer. Buyer A might see a lot of value in your diverse customer base, while Buyer B doesn’t care too much about that, and instead sees the value in the experience and expertise of your employees.
For this reason, it’s crucial that before even considering putting your business up for sale, you reach out for a professional business evaluation. While you may feel you have a good grasp on your company’s value, this removes any doubt that you haven’t overvalued or undervalued your business.
Learn more about our Business Valuation services
How to estimate the value of a company
A business evaluation is a useful tool because it allows the business owner to look at his/her company with a completely objective viewpoint and understand how a buyer might view the organization.
There are several methods that valuation firms, M&A professionals and buyers use to estimate the value of a company before selling, all with various benefits and drawbacks. However, one of the most widely used is the Discounted Cash Flow method (DCF).
Put simply, the DCF uses your company’s projected EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), multiplies this based on market analysis and discounts this based on various risks that are unique to each individual company.
Okay, let’s break this down further: EBITDA is the common metric to demonstrate a company’s operating profitability, as it removes the impacts of non-operating decisions made by the existing management, such as interest expenses, tax expenses and more.
EBITDA is a value that most buyers, investors and analysts will look to find when deciding which selling business is preferable, as it is a strong indicator of its growth potential. This value is determined alongside your company’s other financials over a span of time (ideally 3-5 years) to reassure buyers that this value is consistent and reliable.
Once this is determined, financial professionals can multiply this by a value determined by current market conditions and economic factors, that give a good estimate of the value of your company at present.
Then, by analyzing your company’s unique strengths, weaknesses, opportunities and threats (SWOTs), this value is then discounted based on these to leave a final, well-considered Business Enterprise Value (BEV).
Our valuation team examines dozens of key metrics on each company to discern the level of risk/lack of risk associated with each. Using the Discounted Cash Flow method allows the valuation firm to adjust the rate to factor in the uniqueness of each client, rather than simply end with a generalized assumption based on your company’s industry and financials.
Estimating the value of your business will also require valuations to be assigned to your intangible assets. These are items that won’t appear on your balance sheet, but still have a value in that they set your company apart from your competition. Examples of intangible assets include:
- Patents, Trademarks, or Copyrights – Depending on the industry you are in, these items can have tremendous value to certain synergistic buyers.
- Key Customers – Often a buyer will pay a significant premium over a financial value simply to gain access to a solid, stable customer base.
- Employees –If you have employees with long tenure, recognized experience, and solid credentials, some buyers will be willing to pay a premium for this talent.
- Software —If your software provides efficiencies and benefits that the business wouldn’t have without the software, it is a separate asset.
- Goodwill — Goodwill means many things to many people, but generally it refers to intangibles like reputation, brand name, and location that lead to repeat business.
Identifying and noting these intangible assets are crucial when selling a business, as these could be significant factors that separate the value and potential of your company over competitors when buyers weigh up their options.
How to increase the value of your business
After your company has received a comprehensive business evaluation, you might discover that its estimated value does not match your expectations, or the amount you require to make the next step in your life. In this scenario, before selling the business, it is recommended you apply value enhancement strategies to maximize the potential of your exit.
Naturally, not all business owners appreciate the idea that the business they have poured sweat equity into for years may not be attractive to buyers in its present condition. But the reality is that you can possibly improve your value and sometimes even your deal structure by applying some fundamental strategies.
An immediate way to do this as part of valuing a company is recasting. Most business owners employ legal tactics to suppress profits during their ownership in order to minimize the amount of income tax they pay. While this is a viable approach while running the company, this becomes an issue when selling a business, as it reduces its EBITDA value.
Therefore recasting, a perfectly allowed Generally Accepted Accounting Principle (GAAP), removes the expenses not required on the ongoing operation of the company. This includes features like owner salaries, travel costs, one-off repairs, excessive rents and more.
By ousting these from the equation, you are left with a clearer indication of your company’s profitability and almost certainly a stronger valuation than before your financials were recast.
Alongside recasting, there are several other techniques that can be employed with the aim of increasing a company’s value before it’s sold. Our team employs a Roadmap for Enhancing Value (REV) to map these areas that can be improved and hidden value can be unlocked, so this can be refined and improved over time.
Overall, these refinements will relate to resolving any ‘risks’ associated with your business. Buyers loathe risk in all its forms, and when selling your business it will be beneficial to eliminate as many of these as possible. This will encourage them that your company will be profitable for them and not leave them with excess baggage.
Here are some risks for buyers that should be addressed before selling a company:
Buyers acquire your business for the future, so will be concerned if the success of your company is deeply tied to your leadership. To overcome this, it’s encouraged to build a strong management team around you.
Companies that rely on just one or two major customers raise big red flags for buyers, as if one of these is lost either during or after the transaction, its revenue will likely take a significant hit.
Lack of recurring revenue
If revenue is constantly fluctuating, buyers will be concerned about a business’s ability to generate consistent profits.
Buyers will be troubled if you display any hesitation over your business finances, which is why they expect in-depth, historical records of your financials as part of their due diligence process.
if your expense ratios don’t line up with averages in your industry, buyers will be hesitant to choose your business over one that does reflect it.
This is just a short sample list of typical value enhancements that can be implemented prior to taking your company to market that can make it appreciably more “buyer ready.”
By applying this information on how to determine company value and enhancing it by reducing the risks associated with it, you take a confident first step to selling your business for an optimal value.
Back to top