We're bringing back some great articles to help you and your business. We hope you enjoy!
You've worked hard to get your business to where it is today, but do you know what it's worth?
Given the importance of business value to strategic planning, you'd imagine that every business owner would know the value of their business. However, I've found that isn't always the case. In fact, since business owners are so close to the business and know how much hard work, time and money went into building it up, they are often naturally inclined to over-inflate the value. Of more concern, many business owners expect to retire on the funds generated by the sale of their business. You know what your RRSPs are worth, but do you know what your business is worth? If not, you might be pursuing a pretty risky retirement strategy.
There's another good reason for getting a valuation, too—one that might not be top of mind. Given current economic realities, privately held businesses in all sectors are looking for ways to strengthen their performance, and a valuation might just be the best starting point for growth. Getting to the value is important, but what many often overlook is the strategic advantage in understanding your "value drivers." In other words, it's essential for business owners to understand the factors that enhance business value so they can focus on the metrics that will drive growth.
Arriving at business value is as much an art as a science. Fundamentally, the value of a business lies in its ability to generate future cash flow. One of the most common places to start is an income-based approach. That is, estimating expected future cash flows, and then taking a good hard look at the risks to determine an appropriate discount or capitalization rate.
Another method is an asset-based approach, which adds up the values of the underlying assets and liabilities of the business when it's been unable to generate enough cash flow to provide an appropriate rate of return.
Market-based approaches, which compare a business to comparables within the same industry, are also commonly used. However, for privately-held businesses this can be difficult. Some companies use a valuation formula to simplify the process, but these can often be inaccurate or overly-restrictive.
Once you've run all these numbers, you also have to take into account some of the more intangible factors like changing industry and market trends or the impact of management structures. And then, of course, there's brand strength, customer and supplier relationships, name recognition, patents and trademarks, and proprietary technology, just to name a few. Phew.
Once you've done all of this, you have the magic number – or do you? While value tends to fall within a range, there is never just one value for a business. Buyers will determine their own value – one of the reasons why there are often differences between the "notional value" and the street value when it's actually put up for sale.
The bottom line? Don't wait until you're ready to sell to get a valuation. Understand the business value today so that you can plan for growth tomorrow.
Originally posted June 9, 2014.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
