Valuations – What Is Your Business Worth?
One thing every business owner of a private company should know is – what their business is worth. Surprisingly (or maybe not), many don’t.
Don’t Try This At Home!
We do not recommend owners of private companies attempt to value their businesses themselves. Nor should you take advantage of a “free” business valuation offered by a business broker. In this case, as in so many, you will get what you pay for. Get advice, recommendations, and vet recommended appraisers well-versed in valuing private companies thoroughly before making a decision. A good place to start asking is your virtual CFO or CPA – s/he is likely to know one or more well-regarded business appraisers to provide a reliable and accurate valuation for your business.
Valuing a business’ fair market value, even a small private company, is a process with a lot of moving parts.
Why Should You Know the Value of Your Private Company?
There are many reasons you might want a professional private company valuation:
Gifting of stock to your children
Buying out a partner
Taking on a new partner
Selling your business
Acquiring a business
Merging with another business
These are only a few of the reasons to have your business professional appraised. And the reason you want your business valued matters – be upfront with your appraiser, on this and all scores.
How a Private Company’s Present Value is Calculated
Most methods of private company valuation are based on the business’ expected income going forward. Some of these valuation methods used include:
Seller’s Discretionary Earnings: this is the most common valuation metric used for businesses worth less than $5 million. This approach to valuing private companies takes the business’ pre-tax net income, and adds back the owner’s compensation (plus any excessive salaries paid to other family members), interest, depreciation, amortization, discretionary expenses, and unusual non-recurring expenses to arrive at a valuation. But bear in mind that some lenders may not accept a business valuation based entirely on seller’s discretionary earnings – some of the items, such as high-level salaries to family members, they may decline to add back for their own valuation purposes.
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA): this is similar to seller’s discretionary earnings, in that it takes pre-tax net income, and adds back interest, depreciation, and amortization expenses. Usually, some form of EBITDA or related methodology is used as one prong of an appraisal or evaluation of your business.
Adjusted EBITDA: this approach is a deeper EBITDA dive, adjusting and standardizing your business’ EBITDA via removal of non-recurring, unusual, and one-time expenses and/or income entries. EBITDA may also be adjusted to account for additional staffing or other expenses which a new owner is likely to incur.
Discounted Cash Flow: this approach is most often used for valuing a still-growing concern. The discounted cash flow method projects the value of a business as anticipated future earnings (usually over a period of years), discounted to arrive at the current present worth of those projected earnings. It is one of the most commonly used valuation method when a business is preparing for sale.
Capitalization of Earnings: this method is also widely used, especially for very small closely-held businesses with measurable track records and anticipated stable growth going forward. It projects future earnings based on past growth numbers. This approach, however, is based more on judgment calls than on more technical calculations, and is therefore potentially subject to an appraiser’s personal take.
Asset-based approaches to valuing private companies can provide a bottom line – your business cannot be worth less than the value of its assets minus the total cost of equity and its liabilities. Some asset-based methods of determining market value are:
Net Asset Value Method: this is a simple approach, which assumes that the values of the tangible assets as stated on your balance sheet represent those assets’ market value, and takes into account intangible assets such as transferrable goodwill.
Adjusted Net Book Value Method: this involves adjusting the asset values to more accurately reflect their fair market value. This approach assumes there is no expectation of intangible values, and that there is no transferrable goodwill.
Another approach in determining private company valuation is market-based, such as comparable company analysis. Such methods compare your private company with the current market value of a public company, or more than one, in the same industry, tracking stock prices back to financial statements and evaluating your own financial statements against those of comparable companies.
However, since each individual business, whether a private company or a publicly traded one, has so many specific factors impacting their performance and appropriate pricing that a market-based approach to enterprise value is most often used as a check on income or asset-based valuations.
Things Every Private Company Owner Should Consider
There are a few things we think every owner of a private company should be mindful of:
Your industry affects the value of your business.
The value will be higher if your personal, day-to-day involvement is not necessary for the business to run smoothly.
Sometimes, effective business tax planning strategies can make a business’ bottom line look less attractive than it should – if you are valuing your private company with an eye toward selling it, you may want to consult with both your appraiser and your virtual CFO or CPA as to whether you want to add these back to your bottom line and consider other strategies and practices which can affect your pro-forma EBITDA.
High officer compensation, company perks such as business-owned automobiles, family members on payroll – these are all items which a small business owner may find reduce the business’ value, if they are not added back to the pro-forma EBITDA.
Revenue concentration – too few of your clients generating too much of your income – can reduce a business’ value.
If, indeed, you are contemplating a sale of your business, you may want to have it valued as much as three years or more before you think the sale will be finalized. There may be work to do to maximize the business’ value prior to seeking a buyer.
It’s always a good idea to know your business’ worth – but start the process mindfully, and with open eyes. If you are wondering whether it’s time to get your business professionally appraised, we invite you to consult with us. Based on your individual business, the reason behind the valuation, and your overall goals, we can advise you how best to proceed.
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Until next time –
Want to learn more? Check out our prior posts relating to business valuation: