Understanding Your Company’s Worth: A Step-By-Step Guide to Business Valuations

Originally published in Greenville's Upstate Business Journal

Because business owners are not immortal, every business faces one of two fates at some point: sale or closure. And every business owner—at least, every one we’ve known—prefers the former over the latter. 

Yet, very few of the 15,000 business owners in Greenville—much less the 70,000 in all of South Carolina—have a realistic idea of what their business is worth. This knowledge is not only essential to selling a business; it can also provide a marker for gauging the ongoing success of your business while you are operating it.

When you consider the value of your business, we recommend that you follow these five guideposts:

1) Understand When A Valuation Is Essential, and What Question It Answers

A business valuation can be useful at any point in a company’s life to reference how your organization is performing. However, in some cases, knowing your company’s worth can be the difference between maximizing opportunities and missing them entirely.

A business valuation is critical to these major company transactions:

  • Tax or Estate Planning, where you might ask, “How do I compare my business as an asset to other things I own, like a house, life insurance policy or investment portfolio?” 
  • Transfer of ownership, where people might wonder, “Will I treat everyone fairly when I give an interest in my business to a relative, employee or business partner?”
     
  • Sale of a Business, when the question often is, “How much will someone able to buy my business actually pay for it, and how could I affect that number?”

2) Understand What Factors Influence Value

To truly understand what your company is worth, you must look beyond your balance sheet. The IRS recommends analyzing the following:

  • The nature and history of your business from inception.
  • The overall economic outlook, as well as your industry’s current and projected condition.
  • The financial condition of your business.
  • Your company’s earning capacity.
  • The existence or non-existence of goodwill or other intangible factors.
  • The book value of your company’s stock
  • Sales of the stock and size of the block of stock to be valued.
  • The market price of stocks or entities engaging in the similar line of business.

3) Understand the Best Valuation Approach for Your Business

There is no universal formula for a valuation. The strategy you employ depends on why you’re pursing a valuation and the state of your company and industry. Three basic approaches are used by business valuation professionals:

  • Asset Approach:  Best for distressed businesses or those that will liquidate in the near future, this approach bases a company’s value off the sum of its assets on the balance sheet—both tangible and intangible.
  • Market Approach: Ideal for large, robust and healthy companies, the market approach determines value by comparing the company against businesses within a similar industry, size or geographic area.
  • Income Approach: The income approach values a business based on its generated income and is comprised of two methods—single–period capitalization and multiple-period discounting.

Single-period capitalization, which involves forecasting one typical future year, is ideal if past income has been steady and would serve as a reliable indicator of future income. Multiple-period discounting forecasts three to 10 years or more in some cases, and is ideal for quantifying the value of growth plans or possible future investments.  My experience is that when business owners sell to professional investors, the meat of the conversation is based on a multiple-period forecast of income, discounted to the present.

4) Understand When To Adjust The Answer

The traditional three approaches will guide you to a sense of value for the whole business, but they don’t take factors like marketability and control into account. While such variables do not impact the outright value of a company, they do resonate with the interests of individual shareholders.  For example, how should a grown child think about the value of her interest in a private company versus in a mutual fund?  How should a minority business partner think about the value of his interest in the company when other people make the decisions?

5) Understand How To Leverage Your Value

Once you get the value of your business, don’t let that knowledge sit on a shelf. I’ve found that the insight a valuation provides can serve as one of your best business tools to drive up value.

  • Dig deep into financials to get a comprehensive view of what is driving your business and what is detracting from it. Make your numbers tell the story of what you have built and where it is going.
  • Address customer concentration issues. If more than 20 percent of your revenue stream is coming from one source, diversify your income base to reduce risk.
  • Empower your team so you have well-defined leaders capable of streamlining operations and making quality decisions.
  • Delve into details of existing documents, including contracts and compliance records, to know where investors might see risks so you can address them yourself.
  • Project future growth to help guide your decision making.

Valuing a business can be a complex process—certainly more involved than can be covered in a brief column. To learn more, call a valuation expert at an accounting firm or investment bank.