Business owners looking to merge or acquire another business are wise to conduct a business valuation of their target business to get a better understanding of the target’s economic value. Knowing the value of your business, or perhaps, another business, will help you understand where you are and where you are going. There are many methods business owners can use to attempt to determine the value of a business. Each method can result in a different finding.
Using business valuation methods will make it more easier for you. Even if you use these methods, the information provided herein will help you understand how the process works and what it means to your business.
When you are building businesses, you need to understand how to value them. You may want to work your business long-term, or you may want to sell it while it is in its growth period. In this article, we are going to talk about a few important valuation methods for your business model that all entrepreneurs need to know about.
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Before we get into the various business valuation methods, you need to first, understand what business valuation is. All business valuation methods are best innovative ways to determine how much your business is currently worth. Included in these calculations are the values of your equipment, inventory, property, liquid assets and anything else of economic worth that your company owns. Other factors that might come into play are your management structure, projected earnings, share price, revenue and more.
Business valuation methods will come in handy in multiple scenarios. Of course, you will need to use them if you are in the process of selling your business. However, you will also need to consult them for other situations, such as establishing partner ownership percentages, when seeking financing, or even in divorce proceedings.
Thus, to put it as simply as possible, business valuations are methods to tell how much a business is worth currently. Depending on the type of business valuation you get, your valuation may include your assets, management structure, share price and more. There are multiple reasons you might want to get a business valuation, but the main two are because you are selling or because you are seeking investors.
The size of your business, your industry and other factors can change which type of valuation you need to have. For any confusion, speak with a professional about the best way to move forward. Continue reading below to learn more about some of the best business valuation methods all entrepreneurs should know.
Here are some other common reasons for valuing a business:
(i) For investment purposes: A business valuation can help with settling on a price for issuing new shares.
(ii) To develop an internal market for shares: A business valuation can help to trade shares in a business at a reasonable price.
(iii) To stimulate management: A business valuation can focus the attention and efforts of under-performing management, or reward those who go above and beyond.
Lots of variables affect the value of a business, such as brand reputation, competitors and the wider economy, but the following factors pack the biggest punch:
However, by far, the weightiest factor that affects the value of a business is how much a buyer is willing to pay for it. To reach this figure, you can use a number of business valuation methods.
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Here are the seven business valuation methods all entrepreneurs should know.
This form of business valuation method is similar to the methods used to determine the value of real estate. It relies on the recent sales price of other, similar businesses. Hurdles to utilizing this form of valuation include difficulty accessing data or challenges gathering enough comparable to come up with a realistic value for the business. This method is often recommended as a preliminary approach, best combined with another method of valuation for a more accurate reflection of the business’ true worth.
Market value business valuations are subjective and sellers usually do not want to use this method of valuation when selling their business. Market value business valuation method finds your business value by comparing your business to similar businesses that have sold recently. To get an accurate number with this method, you need to have significant data on the companies that sold.
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Most 7 Business Valuation Methods All Entrepreneurs Should Know In 2019-20 do not have access to this information which makes it difficult to find out how much your business is worth. If your business has enough resources, you can get a decent idea of how much your business can sell for, but you should not use this type of business valuation method on its own.
You should know that no matter what you conclude your business is worth if you are selling your business or looking for an investor, it’s a negotiation process. If you are under stress to sell or find an investor for small business, you are likely to get less money than if you can hold out throughout a long negotiation.
This approach to business valuation focuses on the value of the assets owned by the target business and subtracts all liabilities and debts. This further tends to result in a liquidation value rather than a going concern value of the business. Asset-based business valuation method takes all your business assets like the stocks, business equipment, goodwill and other assets and adds them together. You take your asset value and subtract the liabilities to get your business value.
There are two ways to do the asset-based business valuation, and these include:
(a) Going Concern
(b) Liquidation Value
(a) Going Concern: Going concern is for businesses that do not plan on liquidation. With going concern, your business’ current total equity is taken into account.
(b) Liquidation Value: Liquidation value is for businesses that are finished. When the business is finished all assets will be liquidated and the money from the liquidation will be collected. Liquidation value has a sense of urgency and does not last for long since the value of liquid assets can change.
Investors often consider the return on investment (ROI) before moving forward with an investment. A similar process can apply to the valuation of a business by considering historical cash flows. The market you are in determines what a good return is. Some industries have higher return on investments (ROIs) than other industries naturally. You should research to see where your business falls, so you have an understanding of how your business is doing.
If you are looking for investors, most investors want to know how long it will take to get their initial investment back. Many investors have a number in their head about how much money they want to be able to make off their investment, and if your business does not cut it, they will walk away.
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For instance, if you ask for $250,000 for 25% of your business, you are saying your business is worth $1 million. If you have watched shows like Shark Tank, you must have probably seen plenty of people tell the sharks how much money they want for a certain percentage of their business. Many more times you have seen the sharks laugh them out of the building.
Thus, the point here is to make sure that you understand the figures in your business, so you are using realistic figures. You cannot just say your business is worth $35 million without any proof. Many people find it helpful to have a valuation done by a professional company, so there is no guesswork.
Reported to be Warren Buffet’s preferred business valuation method, discounted cash flow is applied to mature businesses that are heavily invested and predict stable cash flow statement over several years to come – an established energy company with a local monopoly would fit the bill, for example. The discounted cash flow business valuation method estimates what a future stream of cash flow is worth today. The valuation is the sum of the dividends forecast for each of the next 15 or so years plus a residual value at the end of the period.
Today’s value of each future dividend is calculated or evaluated by applying a discount interest rate formula (typically, anything from 15% to 25%), which takes into consideration the risk and the time value of money (based on the idea that a single dollar received today is worth more than the same amount received tomorrow). If the estimated value is higher than the current cost of investment, the likelihood is that the investment opportunity is one worth keeping an eye on.
Discounted cash flow is, however, the most complex way of valuing a business and is reliant on assumptions about long-term business conditions.
This business valuation method is predicated on the idea that a business’ true value lies in its ability to produce wealth in the future. The most common earning value approach is capitalizing past earning. By using this approach, a valuation determines an expected level of cash flow for the company using a company’s record of past earnings, normalizes them for unusual revenue or expenses and multiplies the expected normalized cash flows by a capitalisation factor.
The capitalisation factor is a displayed when rate of return a reasonable purchaser would expect on the investment, as well as a measure of the risk that the expected earnings will not be achieved. This method calculates a business’ future profitability based on its cash flow, annual ROI and its expected value. The Capitalization of Earnings business valuation method works best for stable businesses, as the formula assumes that calculations for a single time period will continue.
Also known as the Times Revenue Method, this formula calculates a business’ maximum worth by assigning a multiplier to its current revenue. Multipliers vary according to industry, economic climate and several other factors.
Lastly, this business valuation method known as “book value” calculates the value of the business’ equity (or total assets minus total liabilities), as per the business’ balance sheet.
If you are selling your business, your business needs to undergo a business valuation. Without a proper business valuation, asking prices are only speculative. While the buyer wants to make the price of the business lower for more of their own profit, the business owner wants to believe the business is worth more.
Having a professional business valuation carried out will ensure the numbers are concrete. Most valuation companies provide your business with a certificate that will show exactly how much it is worth. Get a valuation well before you are ready to make the actual sale to see where you are and what you need to do to make your business more attractive to buyers.
Also, working with a company that has reputation and experience will help you get the best valuation for your business. Do you research prior to working with a company to value your business. Regardless of the reason, how much your business is worth depends on many factors, from the current state of the economy through your business’ balance sheet.