How to Do a Business Valuation
With so many business valuation methods and factors for consideration, business owners may not know where to start when it comes time to do a business valuation. Read on for more details on how to do a business valuation report. But first, check out Coachwell's free Estimate of Value tool from our Value Builder Software to get started on the valuation for your business.
How to Do a Business Valuation
Business owners approaching a business valuation have many factors to consider. What is the purpose of the valuation? How often should one be completed? Who should put it together? The answers to these questions can help direct business owners to the best method (or methods) for valuing their company.
When deciding how to value a business, entrepreneurs should consider the information they want to glean from it. If the valuation's purpose is to get ready to sell the business, consider what information potential buyers or investors want to know. If the goal is to prepare for future growth, gaining an understanding of potential areas for improvement is helpful.
Where a business is in the growth cycle is also necessary to consider when deciding how to do a business valuation. Certain factors or information may not be relevant or available depending on the growth stage. For example, startups will not have the historical data that a mature business does.
For a reliable, accurate valuation, business owners should always turn to a professional. An objective third party with expertise in business valuations can flesh out the finer details to complete an accurate valuation report. Owners can and should complete a valuation of their own annually. However, their time, effort, and investment into their business may lead to a biased over-valuation. For more detailed and accurate valuations, owners should consult with a business coach, broker, or other qualified professional. Especially if the purpose is to sell, obtain a business loan, or seek out investors.
Company Valuation 101
First, what is a company valuation? Simply put, it is a determination of a company's economic value. A seemingly apparent reason to get a business valuation is when getting ready to sell a business. What other reasons might a business owner obtain a valuation of their business? Regularly completing a business valuation report can help a business owner identify areas for improvement. An accurate valuation can also attract investors, help obtain a bank loan, aid estate planning and retirement planning, and even be necessary in the case of litigation such as divorce proceedings.
Business Valuation Methods
There are three general business valuation methods, with more specific approaches under each category. The overarching valuation method categories are asset-based, earning value, and market value approaches. Asset-based approaches consider the investments into a business. Earning value approaches emphasize a company's ability to generate future wealth -- commonly used with mergers and acquisitions. Market value approaches use comparative data from similar businesses that have recently sold.
Whatever the purpose of the valuation and desired information, business owners should work with a business coach or broker to gain insight into factors for consideration they might not have considered. Valuations can involve complicated calculations, but when it comes to factors such as intangible assets, it can be challenging for business owners to incorporate those into calculations. Each business is unique; particularly, when a valuation relies on comparative data or choosing the correct multiple, it's best to seek advice from an expert.
How to Value a Business
There is no one 'right' way to do a business valuation. Business valuations are not one-size-fits-all. Depending on the industry, size of the business, purpose of the valuation, and goals of the company and its owner(s), some methods may be better suited than others. Regardless of these factors, all valuations require the availability of certain information.
Gather useful information:
Whether a business owner is doing the valuation themselves or getting help from a professional experienced in business valuations, start by gathering some of the following:
An updated balance sheet.
Cash flow statements.
Tax returns from the past two to three years.
Organizational documents.
Business plans.
Profit and loss statements from the past two to three years.
Any business forecasts and projections.
A list of intangible assets. Make sure to include any patents, copyrights, contracts and agreements, and domain names owned by the business.
It may also be helpful to start gathering some information on comparable businesses. However, this could be challenging for someone inexperienced with valuations if they don't know where to find the relevant information. Working with a business valuation expert who knows where to find the most accurate information and what businesses are comparable may be the best route.
Considerations for choosing a method:
First, when choosing a valuation method, consider the purpose of the valuation. For example, some valuation methods are better suited for selling a business, while others are better suited for obtaining funding such as a bank loan. A commonly used valuation method when selling a business is discounted cash flow analysis (DCF) due to the ability to predict future earnings. Meanwhile, banks typically rely on EBITDA (earnings before interest, taxes, depreciation, and amortization) to pinpoint a company's debt-to-income ratio, measure cash flow, and analyze the ability to pay back small business loans.
Take some time to analyze all aspects of the company, including the business structure, management, projected future earnings, the market value of assets, etc. Consider tangible and intangible assets, liabilities, and ensure financial statements are well understood. The most accurate valuation will paint a picture of the worth of a business based on all of these considerations. Because some methods exclude some potentially relevant information, the chosen approach matters.
Common valuation methods:
DCF analysis calculates the current value of projected future cash flow based on a discount rate and a time period of analysis. The discount rate used will depend on factors such as risk profile and the current market condition. DCF is an estimate of value that can help investors or potential buyers determine if an investment is worthwhile. However, because the estimate's accuracy relies on choosing the correct discount rate, this calculation is best done by a professional. Additionally, there is room for error depending on the future state of market demand, competition, and the economy.
Book value is a simple valuation method that a business owner can easily calculate on their own with the relevant information in hand. To calculate book value, use the company's balance sheet and subtract any liabilities from assets. Next, exclude any intangible assets. What remains is the value of tangible assets the business owns. The problem with using book value to determine the value of a business lies in its simplicity. Intangible assets, key employees, business relationships, etc., increase the value of a company and are not considered when using book value.
EBITDA is what the acronym describes. It takes the net profit listed on a financial report and adds the interest, taxes, depreciation, and amortization back in to reach the earnings figure. EBITDA is used in calculating ratios that determine value from another perspective and can be helpful when comparing companies. For example, Enterprise Value to EBITDA ratio is a commonly studied ratio that can shed light on growth rate. However, because there is no consideration of expenses in calculating EBITDA, it might not be the best method when preparing to sell a business.
Enterprise value (EV) is often considered one of the most comprehensive valuation methods. EV includes a company's market capitalization plus any short and long-term debt, then subtracts any cash that is not funding business operations. EV is also used as a basis for other calculations that can help analyze company performance. While this method often is considered one of the more accurate valuation methods, a company with a high amount of debt necessary for operations may receive a skewed picture.
Times-revenue method calculates the maximum potential value of a business. An industry-related multiple is applied to historical revenue data to come to an estimation of value. Typically, the previous 12 months' revenue is used to calculate the value of a business using the times-revenue method. Although this method can be useful in predicting the future growth of a business, it is limited in that it does not consider expenses or debt in calculations. If choosing to use this valuation method, it may be best to consult a professional business valuator to determine the correct multiple.
The best approach to valuing a business may be a combination of multiple methods. To get the most accurate picture of a company's value and to get help with strategies to increase the value of a business, it is best to work with an experienced business coach.
Get the Highest Multiple for Your Business
A comprehensive business valuation should include all relevant information and employ multiple methods for the most accurate illustration of value. While it is possible and beneficial for business owners to understand the value of their business through simple evaluations they can complete on their own, they should turn to a professional when the purpose of the valuation is for selling, planning for retirement, or other pivotal transitions. Keep in mind that if a valuation report is not prepared by a qualified professional, it could be discredited much more easily if there is ever a court dispute.
Additionally, a professionally done business valuation report can help owners identify where to make improvements in their business to help increase their multiple if and when the time comes to sell their business.
Coachwell offers professional business valuation reports that provide a customized plan of action to improve your business multiple. Get the process started by taking advantage of our free Estimate of Value tool from our Value Builder Software, and contact us today to learn how our appraisal process can help your business.
