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When it comes to selling a business or even seeing where the company stands, many owners worry, “How much is my business worth?”
This question would most likely be the first thing they ask themselves since it is the most important: the company’s value dictates how much they can get if they sell it. But, before you enter a few figures into a business valuation calculator or base a business valuation on a rule of thumb like a company’s revenue, consider the following points.
The process of valuing a business is complicated. There are no two businesses alike, and a single blunder can cost you hundreds of thousands of dollars, if not millions. Is it worth it?
Let’s first take a look at what company valuation is and a few factors that determine the actual value of a company. From there, we can look at valuation methods and even several valuation calculators you can use to evaluate your business.
What Is A Company Valuation?
Whether you want to buy or sell a business or define the value of your firm to venture capitalists, knowing how to value your company is essential. It may be difficult to untangle your organization’s numerous tangible and intangible components and understand how to calculate their value effectively. The process of determining the entire economic value of a corporation and its assets is known as company valuation or business valuation. During this procedure, all business parts are assessed to identify an organization’s or a specific unit’s present worth. The valuation procedure is carried out for several reasons, including determining the sale value and tax reporting.
When it comes to business valuation, we convert a company’s story, history, brand, goods, and markets into dollars and cents. Businesses also consider community influence and intangible assets when determining their worth Investors, owners, lenders, creditors, and the IRS utilize valuations. The procedure can vary, with results frequently depending on the goal. Calculating the value of any company is both an art and a science. It can be necessary for multiple things, such as if a partnership is dissolving or when investors are looking into financing a business.
Why Would You Need To Do A Business Valuation?
Here are some frequent reasons for a business appraisal for an owner seeking funding, considering a sale, or reviewing a financial plan.
- Litigation – Divorce proceedings, resolving partnership disagreements, and settlements for legal damages all require valuations of the business, as any litigation could affect sales or further proceeds.
- Planning for the Future – An in-depth examination of a business valuation can assist owners in better understanding the factors that influence development and profit.
- Tax and Succession Planning – Valuations are used to estimate estate and gift tax liabilities and plan for retirement. The IRS provides recommendations for tax and succession values.
Transactions Involving Mergers, Acquisitions, and Financing – Valuations are critical in negotiations concerning a company’s sale, purchase, or consolidation. Buy-ins and buy-outs for partners and shareholders are benchmarked using valuations, while lenders and creditors frequently require valuations as a condition of funding. Employee stock ownership plans are also established and updated using valuations.
What Factors Determine The Value of a Company?
There are no shortcuts to valuing a firm; it’s simply that complex a process. The business valuation process involves both an in-depth investigation and an estimate simultaneously. But what criteria go into determining this figure?
- Company size- Because a prospective buyer feels a larger company has less risk than a smaller company, company size is also a determinant in business valuation. A company that has generated 10 million dollars or more in gross revenue while maintaining benchmark or above-average margins is considered a better investment than a smaller one. These businesses are also more likely to have the qualities of a higher-quality firm because they were compelled to grow to this size.
- Profit margin %- Companies with strong gross margins usually attract a premium in terms of valuation. As a general reference, “quite high” gross margins (excluding depreciation expense) for manufacturers and 25% for value-added distributors are considered “pretty high.” Solid gross margins indicate a company’s competitive edge in value, differentiated offerings, unique distribution channels, or improved production capabilities.
- Market size/demand and growth %- Market demand is vital in determining the value of a business since it indicates how necessary the firm is and hence how risky its purchase will be. Buyers’ risk perception will be reduced due to high market demand, which will increase business value. Growth potential is also an essential factor to consider when forecasting a company’s future performance. This will be determined by the existing state of the company and the industry as a whole. A business valuation can consider the company’s growth prospects, especially if your business plan has a lot of room for expansion.
- Management team – Smaller businesses are frequently unduly reliant on the entrepreneurial skills of their CEO/Owner, who may be responsible for multiple major functional areas. If all other factors are equal, the market is more likely to value a company with a more comprehensive management team of outstanding individuals in vital functional areas. Exceptional management teams are familiar among successful businesses. Since senior executives frequently leave when a firm is acquired, acquirers pay close attention to the quality and depth of middle management.
- Competitive advantages- Sustainable competitive advantages help insulate the company from possible competitor encroachment, lowering risk and enhancing growth opportunities. As a result, the market is more likely to pay a higher price for a company with said stopgap, which can include intellectual property, unique capabilities or services, and/or proprietary procedures.
Post Revenue Companies Valuation Methods
When it comes to valuing a private company that already has some revenue, i.e begun to generate sales and is thus in a ‘post-revenue’ stage, is typically done using one of three methods. These methods, listed below, can be used independently or combined.
- Discounted Cash Flow Method – A company’s DCF analysis entails calculating future cash flows and discounting them back to today. The procedure of analyzing mature private enterprises is simple; they have consistent financial data which analysts can use to forecast cash flows and compare to similar publicly traded companies. Calculating the future cash flows of a fledgling company is more difficult as many startups are attempting to expand as quickly as possible, despite the fact that their cash flow may be non-existent or constrained.
- Earning Multiples Method – The multiples approach is a pricing theory that assumes assets sell for similar prices. It assumes that the sort of ratio used to compare firms, such as operating margins or cash flows, is the same. When doing so, they may refer to a financial ratio as the earnings multiple, such as the price-to-earnings (P/E) ratio.
- Net Book Value Method – Companies with a large number of tangible and intangible assets may prefer to calculate the net book value (NBV) of their business such as land, equipment, business premises, and other tangible assets. Non-physical assets such as reputation, patents, and brand are examples of intangible assets. This technique, unfortunately, will miss out on any premium that the market may place on the company’s worth as a result of visionary leaders, growth aspirations, and so on. As a result, NBV tends to produce the lowest valuation among each approach.
Business Valuation Calculators
Business Valuation Calculator offers owners an estimated value based on a determined discount rate, whether they are preparing to sell their company, need a valuation for insurance, or are just wondering about what their business is currently worth. These tools will normally include a colored bar graph or other graphic to assist you see your discounted cash flows over the next 5-10 years.
- CalcXML – In addition to other financial calculators, CalcXML offers a simple business value calculator on its website. Because it simply requires a few variables, it may quickly generate a basic valuation estimate. The program is easy to use and understand, and it only takes a few minutes. After you enter six figures about the company, the tool will show you a visual representation of the valuation after clicking “Calculate.” Because the calculator is so basic, the findings aren’t quite as dependable or thorough. Even though discounted cash flows are used, there are insufficient inputs to produce an accurate appraisal.
- Eqvista – Another excellent business valuation calculator can be found on Eqvista’s website, though they heavily push for those using their calculator to hire one of their valuation professionals to continue the job. The calculator itself is easy to use and allows the owner to choose industry type, years in business, assets, revenue, profit, growth rate, and more to determine the final valuation. The presented graphs are easily readable and well laid out, though of course have their limits due to being a free tool.
- ExitAdviser – ExitAdviser is designed for small business owners who prefer to handle the sale of their company themselves. The section of the Business Valuation Tool that is open to the public is clear and simple to use, and it does not require registration. For a four-year period, you must enter in the most recent figure for Net Profit and their anticipated Growth Rate. As a consequence, you’ll receive calculations that illustrate the suggested asking price, the DCF calculation result, and a table that shows the calculations in order. Only individuals who have purchased a subscription plan will be able to download the entire report of the appraisal. It is possible to perform more advanced company valuation calculations after acquiring the Business Valuation Tool membership, albeit the calculations are still confined to DCF related algorithms. Most significantly, you have access to a detailed valuation study that outlines the determinants of the company’s value in greater detail.
- BizEz – A free simple business valuation calculator is available from BizEx. It simply requires a few inputs, so you can get a rapid valuation. Because the input is limited to only a few figures, the BizEx calculator’s findings can be prone to inaccuracies. The results are simple to understand, however, as the results page displays the business’s valuation as well as the financials from the most recent input year. If you’re interested in selling their business, BizEx also gives you the option of contacting their broker. You can ask BizEx’s broker to contact you by submitting your personal contact and corporate information.
Final Thoughts On How To Increase The Value of Your Company
While some business owners are willing to accept a lesser valuation, others desire to increase their firm’s value by making it more appealing to purchasers.
Here are five techniques to raise the value of your company:
- Develop An Indispensable Product – A company’s most essential and fundamental goal should be to meet the requirements of its consumers and solve their problems better than anybody else. Companies that provide optional services or products (nice to have but not necessary) will have difficulty attracting and retaining customers significantly harder. That is, find a way to make your product or service indispensable to your clients whenever possible.
- Diversify Your Income Stream – Buyers want to see increasing revenues, not just the overall cash amount; they want to see that revenues grow and stay at a higher level. That is why it is critical to diversify your sources of income. The more money-making opportunities you have, the better your outcome will be. These opportunities can come from focusing on new customer groups or adding new products, whatever works best for your business.
- Minimize Uncertainty – Business leaders frequently make the mistake of making bold predictions that aren’t backed up by facts and numbers—essentially exaggerating the company’s future value. However, this is the quickest method to lower your company’s value. The more implausible the upside, the less credible you appear, which often leads to lowball bids. You must provide your buyer with reasonable and verifiable estimates. Because the interests of buyers and sellers are rarely aligned, buyers are understandably wary of seller forecasts.
- Position Your Team Well – A winning executive team is often enough to tempt buyers to look at a business. After the sale, this team will be crucial to the company’s success, and a buyer may have to find other personnel to run the business if the team isn’t strong enough. In addition, if the CEO intends to step down, an apparent successor must be found and have held the position for at least six months before the selling process begins. Buyers need to understand that the company will continue to operate even if the owner is no longer in charge. If the owner is seen as “indispensable,” this poses a significant risk and may lower valuation.
- Look To Future Growth – Companies are more likely to pay a more significant amount of money if they can see a clear path to better profits in the future. Sellers must thoroughly understand what buyers want from the sale and employ the appropriate technique to assist them in achieving their objectives. High-quality, justified financial forecasting, both quantitative and qualitative, can predict future outcomes and is highly
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