If you own a small or medium-sized business, it’s important that you’re always thinking about the value of your company. And whether you plan to sell this year or simply want to pass the business to a loved one in the future, you should always know your “number.”
Why Your Business Valuation Matters
Most business owners never bother to get a valuation for their business. They assume that it’s only necessary if and when they plan to sell their company. However, there are plenty of other reasons you should know the value of your business. Here are several of them:
- Contextualizing growth. A business valuation gives you a clear starting point and benchmark to analyze against your growth. It tells you how healthy you are financially and arms you with the context needed to make smart growth-oriented decisions.
- Attracting investments. As a business owner, understanding your company’s valuation will help you engage in intelligent conversations with potential investors who want to partner with you on future initiatives. Without an understanding of your value, you’ll either get taken advantage of or laughed off.
- Approaching retirement. If you’re like most business owners, your business plays a key role in your retirement planning. By getting a business valuation sooner (rather than later), you can work with your financial advisor to get a better feel for how much supplemental retirement savings you’ll need.
- Implementing an exit strategy. Every business owner needs some sort of exit strategy. Whether it’s selling the company to an outside investor, passing it along to an adult child, or seeking to be acquired by a larger company, knowing your business valuation allows you to make more educated decisions.
- Selling your business. The most obvious reason to get a business valuation is for the purposes of selling. As Apex Business Advisors explains, “Putting your business up for sale without having a business valuation first puts you at risk for being overpriced or leaving hard-earned proceeds on the table. A small company valuation performed prior to selling your business establishes a reasonable market price.”
4 Ways to Determine Your Company’s Value
Understanding the value of your business can give you a much more accurate understanding of your company’s present status and future opportunities. With that being said, here are some different ways you can determine your company’s value.
1. Asset-Based Method
The book value – also known as an asset-based approach – takes your assets minus your liabilities and gives you a number. In other words, if you have $1 million in assets and $200,000 in debt, your valuation would be $800,000.
This method does provide a decent snapshot of what the company is worth, but it doesn’t take into account the company’s potential. For example, if the company has an annual net profit of $500,000, the company is obviously worth far more than $800,000. Likewise, if the company is only breaking even each year, a buyer would be hard-pressed to fork over this much money. All of that being said, use an asset-based approach in conjunction with other methods mentioned.
2. Discounted Cash Flow
This approach is very much focused on future performance instead of historical data. It basically estimates future cash flow while factoring in various risk factors. It’s generally a pretty good option for business owners/sellers. However, buyers will often complain that the numbers aren’t realistic enough.
3. Revenue and Earnings
With this approach, you take your gross income/earnings and use an industry multiplier to produce a value. In some industries, the multiple is five-times sales. This means a company with $100,000 in gross revenue would be valued at around $500,000. Every industry has a unique multiple and a different way of calculating valuations, but this at least gives you an idea of how it typically works.
4. Market Comparison
If you’re in an industry with lots of competition and a number of transactions that have occurred in recent months, you can always use market comparison to get a feel for how much your company is worth. Simply look for similar companies (based on location, revenue, industry, etc.) that have sold in the last two years and base your valuation on that figure. If nothing else, it’s a good starting point.
Do You Know Your Number?
No business valuation is perfect. However, the more serious you are about getting a proper valuation, the more informed you’ll be regarding decisions related to growth, investments, retirement, exit strategies, and future mergers or acquisitions. Now’s the time to lean in and get serious about your numbers.