Determining the estimated value of a company or business – which is known as valuation – can be a sophisticated, time-consuming, and complicated process. It takes into account the financial performance of the company over multiple years, market prospects, all tangible and intangible assets, the sector the business is in, the customer base and demographics, intellectual property rights if any, and the company’s location.
Overall, a business’s worth is a function of the profits and cash flow it can generate, as well as the time value of money. It’s a compilation of factors such as the fair market replacement value of equivalent operating assets, company’s sales, earnings, performance, market outlook, personnel, as well as the net book value.
Moreover, a company’s valuation is also influenced by intangible assets such as the company’s image, reputation, relationships with customers and suppliers and goodwill.
It should be noted that valuation of a business is subjective science. It is essentially the price that a buyer and seller agree to in a good faith negotiation, which may be a merger or acquisition transaction, dilution of owner’s equity, or a buy-out.
Why is valuation relevant
There are many reasons that necessitate a business valuation.
Ideally, a business owner should start valuing his or her business right from the start-up stage. Valuation matters to entrepreneurs because it determines the share of the company they have to give away to an investor in exchange for money.
Other reasons may include an internal restructuring, an acquisition or a share swap, an incoming external investment, separation of partners, tax and insurance planning, or succession and retirement planning.
No matter which stage one’s business is at, in terms of revenue, product, number of employees, partnerships, branding — valuation gives the business owner a sense of direction and enables the owner to envisage the future. With the evaluation information, business owners can deploy strategies to fuel growth, possibly by attracting investment in return of diluting some equity.
How is valuation done
Every business would require a different perspective on its valuation, depending on the stage of the business’s life cycle and its desired outcome. For example, if one is looking for an exit, what happened in the past and what is happening in the present would drive the valuation estimate. Whereas if one is looking for investment, future growth potential takes utmost importance.
Insiders agree that valuation is an art form. There is thus no definitive right or wrong way to arrive at a number.
You should always be mindful of the following when calculating what your business is worth:
- Always factor in the non-financials;
- Subtract the personal expenses and recast the financial statements;
- Apply a method to your madness and use multiple methodologies to cross-check valuations;
- Enlist a professional so that all emotions are checked at the door
In terms of valuation methodologies, there are three widely accepted approaches that experts adopt:
- Income approach which transforms profits or cash flow into estimates of value by way of multiples, capitalization rates and discount rates
- Market approach which analyses the recent sales of comparable businesses
- Rules of thumb approach which includes using simple and powerful valuation methods regularly adhered to by market participants
While there are many popular methodologies to conduct a valuation, the two most popular ones are – the Discounted Cash Flow method (DCF), and the Comparative Ratios method.
Discounted Cash Flow (DCF)
This popular method – while tricky to get right – determines a company’s current value according to its estimated future cash flows. It is used to estimate the attractiveness of an investment opportunity.
According to Investopedia, “DCF analysis uses future free cash flow projections and discounts them to arrive at a present value, which is then used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one.”
In this method, there are two types of ratios that an acquiring company uses to make a purchase offer that is a multiple of the earnings of the target company. These include:
- Price-Earnings Ratio (P/E Ratio) – looking at the P/E for all the stocks within the same industry group
- Enterprise-Value-to-Sales Ratio (EV/Sales) – looking at the price-to-sales ratio of other companies in the industry
What InCorp can do for you
No matter your desired goal, you would want a good advisor to help you assess the value of your company. This process takes experience, knowledge, and the ability to subjectively assess the market conditions.
InCorp Group possesses the in-house knowledge and experience to evaluate businesses and determine their estimated market value. We do this by understanding your business, industry, pain points, USPs, customers, and organizational structure by spending time with your team prior to the valuation analysis.
As testimony to our success, we have a strong track record of serving as consultants for transactions relating to business value for internal sales, family sales and partnership buy-outs, and for estate planning purposes.
Get a professional perspective on your business valuation
With InCorp’s team of expert advisors, we ensure your business worth is measured right.