The first step in any business sale is knowing how much your business is worth. It is not uncommon for savvy buyers to take advantage of unprepared sellers who have no idea what their company is worth, so it is fundamental to include a professional valuation as part of any effective exit strategy. However, when many business owners decide to sell, they are often left asking “How do I value my company?"
There is no one simple answer to this question, as there are several different ways to value a company. Each has its own advantages and disadvantages depending on a number of factors, from the current economic market, and interest rates to industry valuation norms. Choosing the right method to value your business will play a significant role in the return on your investment when you exit.
One of the biggest errors business owners can make when approaching a company valuation is not seeking professional guidance. With the amount of time and energy you devote to running your business, it is virtually impossible to look at this objectively. With guidance from a leading middle-market valuation firm like Generational Equity, you will learn how to unlock hidden value in your business financials.
Here, we offer an introduction to three of the most common company valuation methods and how they can be applied to your business.
Every business is constructed of assets and liabilities. By calculating the difference between these assets and your liabilities, you will be able to estimate the “book” value of your business. Rather than showing the profit-generating capabilities of a company, this method offers the current net worth, on paper, of the company.
For this reason, this approach is often used when a company goes into liquidation. In this situation, an owner is often being forced to sell for less than optimal reasons. However, the best time to consider selling to get the optimal deal is when your business is doing well and making money. This approach doesn’t consider future earnings, so it is usually not the best method for a prospering business.
Asset accumulation is easy to calculate and will provide the minimum value of a company. However, one of the greatest disadvantages of this method is that for many businesses, the value of equipment and machinery has been fully depreciated so the book value is typically far below the actual value of the equipment and machinery upon liquidation. And again it does not take into account the most important factor: The future earnings of the company.
For smaller companies, an approximate business value can be based on the valuation norm within the industry that you operate. This is important through the eyes of a business buyer, who will be aware of the ‘standard’ company worth for a specific industry.
Providing there are enough similarly-operated businesses within your industry, this simple approach offers a sound valuation benchmark that encapsulates the current market. Comparable valuations can be used as a rule of thumb to estimate the value of a company and is a great way to support your offer or asking price.
However, a cause for concern when looking at industry valuation norms is the reliance on the assumption that companies operate in the same manner. While also depending on the notion that other companies in your area have been accurately valued, no two companies are alike, which can often lead to comparing apples to oranges. Using this method as the sole valuation tool risks leaving the business seller, especially first-timers, disappointed at the difference between the predicted value and the final offer.
Also, keep in mind that any multiple that you read about that is “standard” for your industry is at best, an average of all completed deals historically. The downside to using any average measure is that it is an average value. In the real world, this means that there are companies valued above and below the average. And do you have an average company? Or is it an over-performer.
Secondly, industry norms are by their very definition are created using years of historical data. Again, it does not factor the future in at all. So this method is less than optimal if you are valuing your business. However, keep in mind that buyers use this method because they know it will usually undervalue the company they want to acquire.
The true value of a business lies in its capacity to produce wealth in the future. Unlike the previous two methods, an income approach such as DCF takes into consideration the expected future earnings of a company together with the risks the company faces. This offers a well-rounded approach towards an accurate valuation of a company’s worth for both sellers and buyers by calculating the current value of the future wealth generated.
In order to determine this, it is necessary to project the EBITDA of your company for future years, which will typically be a five-year projection. A high level of accuracy is required when forecasting future cash flow, which is why we encourage business owners to talk to our experienced valuation team.
Next, the rate of return that will make this business purchase a worthwhile investment is considered and a discount rate is determined. The discount rate reflects the risk of reaching the projected income. This rate is applied to your future earnings and the current enterprise value of the company is determined.
So the DCF is dependent on two factors: Your projected earnings (usually EBITDA) and the discount rate used. Not surprisingly, the higher the discount rate, the lower your business enterprise value today. Conversely, the lower the discount rate the higher your business will be valued (all other things being equal).
And what determines the discount rate? The level of perceived risk associated with your projected earnings. This is why we strongly counsel our clients to work with us to create believable, defendable projections of revenue, expenses, and EBITDA. The more realistic, the lower the risk associated with your business.
Also, it is vital that before you create our pro forma projections, that you “recast” your historical financials to reflect the true profitability of the company. Let’s be honest, over the years you and your account have worked really hard to reduce your tax liability. There is nothing wrong with this, it is perfectly legal and acceptable.
However, if you don’t recast or normalize your historic numbers, you could be radically understating your company’s true profitability, thus misrepresenting your future profits, and hurting your company’s DCF value calculation. So be sure to have your financials recast by an experienced M&A advisory firm like Generational Equity before applying the DCF model.
Finally, keep in mind that we have presented only three methods of business valuation, there are lots of others. If you hire an experienced M&A firm to work with you, they will ultimately use a number of methods in combination to come up with the one (or several) that make the most sense for your company. Again, this is another reason why you need to work with a team that has experience in wide range of valuation methodologies.
Being unaware of the different company valuation methods available to you could stand in your way of achieving the optimal value for your company. If you are interested in learning more, set aside a few hours to attend a Generational Equity executive conference. These complimentary, no-obligation conferences run throughout North America and provide a highly educational opportunity for business owners to understand how much their company is worth.
As one of the leading M&A advisory firms in the lower middle-market, Generational Equity provides the necessary information, guidance, and support throughout the entire M&A process – starting with your business valuation. For more information, follow these links:
Tom Staszak is one of the most professional people I have dealt with in my last forty years of business. You’ve got a great group of people and you have built a truly professional organization.Michael J Polarek, President, Paragon Packaging
Greetings Mike. Thank you for the captivating and compelling presentation you made at the Phoenix presentation last week. Over many years in business yours was the most informative and well-presented presentation, on any subject, that I have ever attended! Your energy and enthusiasm combined with your concise and captivating support of your positions with easily understood examples and data was compelling.Pete L.
We were happy to see the interest in our company and what we cherished has not just a valuable company but an important company to the communities we served in.Larry Moore, Owner, A Company Portable Restrooms
I would like to thank you and your firm, Generational Equity, for being our valued advisors in our journey.Bil MacLeslie, CEO, ipHouse
We thank you Eric and Generational Equity making our dream come true.Larry Moore, Owner, A Company Portable Restrooms
I wanted to write you a quick letter to express our appreciation and our delight on the outcome of helping us through the process of our recent sale. We are very happy with the end result, and are very happy to be able to move forward with all of our future growth plans.Terry D. Wickman, President, Keytroller
The process was much more involved than I expected and your help, experience and advice was a big factor in making the negotiations go as smoothly as possible.Terry D. Wickman, President, Keytroller
Michael worked tirelessly, He followed every lead meticulously and urgently to make sure nothing was missed.Robert Evans, President and CEO of Mealtracker Dietary Software
Your wisdom and experience were invaluable to me during this once-in-a-lifetime transaction.Ralph Noblin, President of Noblin & Associates
I quickly recognized that Don was working for Sharpe Mixers above all else, and held our interests above others.Jay Dinnison, Owner of Sharpe Mixers
We will highly recommend Generational Equity and Musa Jagne to any business owner about to embark on the same process.Karen S. Williams, CFO, BW Manufacturing
Bruce and I wanted to take this opportunity to thank Generational Equity for assigning Musa Jagne to our transaction. In Bruce’s words, “Musa did one hell of a job for us!”Karen S. Williams, CFO, BW Manufacturing
Thank you again for all your guidance and support. Any company will achieve what they intend, if they have you on their team!Rick Nowak, President/CEO, Kurz Electric Solutions, Inc.
Generational Equity educated and informed us – so that we could be on the upside of a good decision (to sell).Bil MacLeslie, CEO, ipHouse
I couldn’t have asked for a better team than Michael and Deborah. We couldn’t have done it without them.Robert Evans, President and CEO of Mealtracker Dietary Software
Generational Equity’s assistance was invaluable in compiling and marketing our business.Bil MacLeslie, CEO, ipHouse
We knew it would be a difficult task to have someone really understand our business and our market, prior to researching a possible buyer, so it was imperative that we found someone of your caliber, with definite proven experience in this area.Rick Nowak, President/CEO, Kurz Electric Solutions, Inc.
We are very happy with the end result, and are very happy to be able to move forward with all of our future growth plans.Rick Nowak, President/CEO, Kurz Electric Solutions, Inc.
We are extremely pleased with the way Generational Equity handled the sale of our company. Your associates, Tom and Chris, did an outstanding job of getting us (me) through the process.Michael J Polarek, President, Paragon Packaging
Thanks again Phil and feel free to have a future client call me if they would like a referral. You are a true professional!Andy Graham, Vice President, Modern Heating & Plumbing
The help you provided us during each step of this process made us feel very comfortable and confident we were selecting the right approach to transition our Company.Andy Graham, Vice President, Modern Heating & Plumbing
I must say that I have never worked with a more driven, competent and focused individual as Don Ho.Jay Dinnison, Owner of Sharpe Mixers
The information we learn from customers helps us personalize and continually improve your experience. Here are the types of information we gather.
We receive and store any information you enter on our Web site or give us in any other way. We do not sell or rent your personal information to others without your consent. We use the information we collect only for the purposes sending promotional information, enhancing the operation of our site, serving advertisements, for statistical purposes and to administer our systems. We DO NOT use third parties to provide customer service, to serve site content, to serve the advertisements you see on our site, to conduct surveys, to help administer promotional emails, or to administer drawings or contests, but reserve the right to do so in the future without advance notice.
By submitting my name electronically and clicking the “submit” button, I understand that I am providing Generational Group, Inc., Generational Equity, LLC, Generational Capital Markets, LLC, DealForce LLC, their affiliates, representatives, contractors, etc. (“Generational Group”) my telephone number, which may include a number that is wireless and/or a number that is on a national, state, or other Do Not Call registry or list. I hereby consent and agree to receive telephone calls including any autodialed and/or pre-recorded telemarketing calls and/or text messages (telemarketing) from or on behalf of Generational Group at the telephone number provided. I further consent and agree that telephone calls may be made using automated technology such as an automatic telephone dialing system, artificial or prerecorded voice, or SMS text messaging. Consent is not a condition of purchase. I further warrant and represent that any telephone number provided is not on any state or national Do Not Call Registry and that by agreeing to these terms and conditions that if any number provided is on any such registry, I hereby consent and agree to receive telemarking calls and/or communications including any phone calls, text messages, URLs, links, emails, etc. to the telephone number(s) and/or any e-mail addresses provided. I understand that by entering my name in the electronic form provided, that I am signing my name as equally as if it was my handwritten signature and that it is my intent to provide an “electronic signature” as that term is defined in state and federal law, as well as industry practices for e-commerce.
For reasons such as improving personalization of our service, we might receive information about you from other sources and add it to our account information.
Generational Group may license the use of its intellectual property including but not limited to its name, likeness, and logo for the use of affiliated offices. Such affiliated offices may not be owned, controlled, managed, supervised or staffed by employees, officers, or agents of Generational Group. Affiliated offices may be independently owned and operated. For more information about a particular office, please contact Generational Group at its office in Dallas, Texas.
This page may contain other proprietary notices and copyright information, the terms of which must be observed and followed.
Information on this web site may contain technical inaccuracies or typographical errors. Information may be changed or updated without notice. Generational Group may also make improvements and/or changes in the products and/or the programs described in this information at any time without notice.
Generational Group does not want to receive confidential or proprietary information from you through our web site. Please note that any information or material sent to Generational Group will be deemed NOT to be confidential. By sending Generational Group any information or material, you grant Generational Group an unrestricted, irrevocable license to use, reproduce, display, perform, modify, transmit and distribute those materials or information, and you also agree that Generational Group is free to use any ideas, concepts, know-how or techniques that you send us for any purpose.
Our computer system protects personal information using advanced firewall technology.
Information Generational Group publishes on the World Wide Web may contain references or cross references to other products, programs and services that are not announced or available in your country. Such references do not imply that Generational Group intends to announce such products, programs or services in your country. Consult a Generational Group representative for information regarding the products, programs and services which may be available to you.
Generational Group makes no representations whatsoever about any other web site which you may access through this one. When you access a non-Generational Group web site, please understand that it is independent from Generational Group, and that Generational Group has no control over the content on that web site. In addition, a link to a non-Generational Group web site does not mean that Generational Group endorses or accepts any responsibility for the content, or the use, of such web site. It is up to you to take precautions to ensure that whatever you select for your use is free of such items as viruses, worms, Trojan horses and other items of a destructive nature.
IN NO EVENT WILL Generational Group BE LIABLE TO ANY PARTY OR ANY DIRECT, INDIRECT, SPECIAL OR OTHER CONSEQUENTIAL DAMAGES FOR ANY USE OF THIS WEBSITE, OR ON ANY OTHER HYPERLINKED WEBSITE, INCLUDING, WITHOUT LIMITATION, ANY LOST PROFITS, BUSINESS INTERRUPTION, LOSS OF PROGRAMS OR OTHER DATA ON YOUR INFORMATION HANDLING SYSTEM OR OTHERWISE, EVEN IF WE ARE EXPRESSLY ADVISED OF THE POSSIBILITY OF SUCH DAMAGES.
Furthermore, all information contained within this website is the property of Generational Group.
Honored to win Investment Banking Firm of the Year 2 years running.
Over 50 awards and counting.
Sign up to receive regular email updates, industry-leading insights and details on complimentary M&A executive conferences in your area from our award-winning team
Success, you have been added to our list.