Choosing the best valuation method for your business

Is it time to sell your business? Curious what your company’s net worth is? Keen to bring investors on board? Regardless of your motivation, it’s important that the valuation your business receives is an accurate one.

Different businesses require different valuation methods. As such, there are several common methods valuers use to make their decisions.

The Asset-Based Valuation

Every business has assets and liabilities.

Assets come in two forms, tangible and intangible. Cash, equipment, and property are all considered to be tangible. Whereas assets that generate revenue but are non-physical, like intellectual property, brand recognition, location, customer relations or staff quality represent intangible assets.

The sum of a business’ non-physical (intangible) assets is often referred to as their ‘goodwill’.

A company’s liabilities are things such as debt or outstanding payments.

An asset-based valuation totals a business’ assets and subtracts the liabilities. That may sound simple enough. But it’s actually a complicated process.

Which is why it’s important to work with a valuer that has experience working with businesses inside your industry.

Because it can be easy to overvalue your business assets which can have an adverse effect on a company’s pending sale.

If you’re looking to sell because your business has been underperforming or struggling and goodwill is low, an asset-based valuation is likely for you.

It’s also a great option for newer businesses or businesses where the sale of the actual assets would mean more than the sale of the business itself.

The Earnings-Based Valuation

For businesses that are performing well, and expected to grow, there’s more to consider than current assets. Buyers are concerned with future profits the business could potentially generate, so valuers keep this under consideration when preparing an earnings-based valuation.

An earnings-based valuation considers a company’s capitalised future earnings. What a buyer can expect to make from the business after buying it and its return on investment (ROI), is every bit as important as a business’ physical and non-physical assets.

There’s also the role earnings before interest and tax (EBIT) has to play in determining the value of a business.  It’s a process by which annual earnings before interest and tax are multiplied by a number based on projected growth and profitability.

The more consistently a business has performed will determine the multiple. The better the performance, the higher the number.

The Market-Based Valuation

Market-based valuations are thought by some to be the most accurate of these commonly used methods.

Relying heavily on the recent sales of similar businesses in your area, valuers analyse the specifics of those sales, and compare them to your business to determine the profit multiplier to be used.

Due to the confidential nature of some business sales, this information is not always easy to come by. But when it is available, it can help to paint the clearest picture of what your company is worth.

Other Considerations

Business is about relationships. Forming them. Maintaining them.

Depending on the type of business, who’s behind running it can have a serious effect on its value. So the change of ownership also becomes a part of the equation.

If ownership of a favourite, local restaurant with a beloved owner changes hands, and that owner is no longer a presence, it will likely have a negative effect on business. At least initially.

On the other hand, if a new owner purchases a McDonald’s at the end of the street, it’s likely to have little to no impact on the restaurant’s capacity to profit.

Disruptive innovation is another factor that will be on the mind of both the valuer and potential buyer. In some industries, it’s simply a matter of updates and keeping systems and processes current.

For other businesses, the market can be disrupted or even displaced by technology in the way that Uber has affected the taxicab industry.

Similarly, valuers will take into consideration whether or not the target market for your business is increasing or decreasing. If the market for your particular type of business is secure, it’s likely to receive a better profit multiplier and be valued higher than a business who may be generating an impressive annual net profit, but has a target market that his shrinking.

Profit and cash flow are not the same things.

No matter what your finances look like on paper, if cash isn’t steadily flowing into the business (i.e. your customers are slow at paying their bills) this will impact upon the valuation.

Preparation

Regardless of which type valuation you ultimately decide to go with, the first thing you’ll want to do is collect and prepare as much information about your business that you can.  

With an asset-based valuation, that means you’ll need to conduct a full audit of all your tangible and intangible assets.

You’ll also need a complete list of any business liabilities. This would include any contingent legal proceedings, taxation obligations or debts that would subtract from the company’s overall value.

Earnings-based valuations require detailed financial information going back at least 3-5 years. Profit and loss statements, cash flow statements, and any outstanding debt will need to be brought to the valuer’s attention.

But it’s not just the business’ past that will be of interest to both the valuer and the buyer. They’ll have a serious interest in the potential your business has to make them money moving forward.

Marketing plans, competitor analyses, customer profiles, sales reports and forecasts will all help to make the valuation and sales processes as transparent as possible.

A valuation is as much an art as it is a science. Chances are, a good valuer will use elements of all three of these common methods to arrive at the opinion of what your business is worth on the open market.

At the end of the day, a business is much like anything else you might be trying to sell. Ultimately, it’s only worth what somebody else is willing to pay for it.