Knowledge of a company’s true value is essential for business owners. This is particularly true prior to a potential transaction with a third-party, where an owner has been approached by a prospective buyer or when an owner may be considering selling the business at some time in the future. In all these situations, an owner must know their business’ true value in order to determine their next move, although most owners are at a loss as to how to determine this value.
Unfortunately, some owners will underestimate their business and its value, which can cause them to leave a lot of money on the table and ultimately come up short in future transactions. Conversely, some will overestimate the value of their business causing them to be left empty-handed as they turn down a reasonable price for their business because they mistakenly think it is worth much more.
Therefore, it is critical to have a realistic value of what your business is worth prior to beginning a transaction. A common, and often very costly mistake, is to just use the business’ reported earnings as the sole basis for the valuation. Reported earnings often do not paint a complete and accurate picture and can give an erroneous picture of the company’s true worth. Therefore, other factors need to be considered as well, such as normalized or adjusted earnings, which will factor in things like excessive salaries and expenses that are really owners’ perks.
The best way to determine value is to start by looking at earnings, but then to dig deeper and examine the “quality” of those earnings so that you can see the unique qualities of your business that could add or detract significant value. For example, if you sell into a certain geographic or demographic niche that prospective buyers are eager to penetrate, then buyers would be willing to pay more for your company because of the “value” that this niche brings to them.
On the other hand, there are factors that could lower valuation. Questions to ask yourself include: Are there customer or supplier concentrations? Would the loss of a key customer lead to a significant negative impact on your revenue?
A key aspect of valuation is to take the perspective of the buyer and to not focus on what the business is worth to the owner, but what it is worth to a potential buyer. Buyers are looking to take your business to the next level – you should therefore address and weigh the current value of the business as well as the potential value to the prospective buyer. That value includes intellectual property, a market niche, client base, or other strategic aspects that could be lucrative to a buyer.
As an example, one US company we sold was a manufacturer of cleaning products, their customers were the Department of Education in most of the 50 states. They were bought by a European manufacturer, who valued the relationships, (more than the products) and wanted an entrée into these DOE’s. They were willing to pay a significantly higher multiple to gain access to this market niche.
To determine the true value of a business, many factors need to be considered. While an accountant can determine the value based purely on the numbers, an investment banker will combine solid financials with a broadened view that can provide different vantage points on the soft details of your business and find the added value in your company. Select a firm which has experience with M&A and valuations and a group who is familiar with selling companies like yours.