5 Central Reasons For Business Valuations
Discover the central reasons for conducting a business valuation. Learn how valuation impacts your company’s future and financial health.
Published 11/4/24
Ever wondered what your business is worth? In the ever-evolving world of business, understanding the value of your company is not just smart—it’s essential. Whether you’re a small business owner, an entrepreneur, or a stakeholder, knowing your business’s worth shapes your financial future. From navigating M&A (Mergers and Acquisitions) to mapping out employee incentives, a solid business valuation is your compass, leading the way for critical business decisions.
Once you’re ready to get your business appraised, consider reading our article about how to know what your business is worth, or take the guess-work out of the equation: meet with a bridge advisor or get a business valuation today.
Understanding Business Valuation
What’s Business Valuation, Anyway?
Treat a business valuation as a financial health check-up for your company. It’s a thorough look at the business’s assets, debts, income, costs, and market position. Although the valuator gives you a number for the worth of the business, the valuation is much more than a number. It’s a clear vision, a powerful tool for any leader. A business valuation is irreplaceable for navigating many situations discussed below. It will enable you to make smart choices, negotiate better deals, and prioritize what’s best for you and your stakeholders.
So, How Do You Do It?
There are quite a few options for business valuation, but most fall into three main categories:
The income approach
will take the form of your business’s income (EBITDA, Revenue, etc…), multiplied by a certain multiplier. This is often based on the industry and the current state of the economy.
The market approach
compares your business either to similar ones that have recently been sold (precedent transactions), or to public companies whose market capitalization is known. Market cap is an appraisal method where you multiply the share cost by the total number of outstanding shares.
The asset approach,
or book value, is essentially what results if all the business’s physical assets turned into cash with which to immediately pay any debts.
One more method that is frequently used, but doesn’t fall too well into these categories, is the Discounted Cash Flow (DCF) analysis. Think of DCF analysis as your financial crystal ball. It estimates the current value of a business based on its projected future cash flows. This method is most useful for companies with stable cash flows, and is widely regarded as a good way to see a company’s intrinsic value. However, small assumptions can have outsized impacts on the result, so it must be done with precision.
A time-tested approach for business valuation is to combine all 3 approaches, allowing a comprehensive assessment. This ensures nothing critical is overlooked.
The 5 Central Reasons For Business Valuations
Mergers and Acquisitions (M&A)
Determining a Fair Selling Price
Thinking about selling? A valuation helps you set a fair, competitive price. You won’t always sell at this price, but it gives you a foothold in negotiations. Whether you get a valuation early and improve your business or get one at a “photogenic moment” (1), it makes your business attractive to potential buyers.
Assessing Potential Acquisition Targets
Alternatively, if you want to acquire a business, a good valuation tells you if the seller’s asking price is reasonable. This ensures you make a good investment, as a business valuation will give you a holistic picture of the business.
Strategic Planning and Growth
Identifying Areas for Improvement
A business valuation is like a business roadmap. It uncovers strengths and weaknesses in your business operations, allowing for significant improvement. The M&A Source (2) informs that “[a valuation] can also serve as a meaningful tool as part of a business “gap analysis” to help identify and eliminate the various anchors to value growth” (2). Whether it’s optimizing operations or reallocating resources, this insight is invaluable for strategic growth.
Guiding Investment Decisions
Knowing the value of your business can guide your investments in time, money, and resources. You can prioritize projects that enhance your company’s value the most, stretching the limits of long-term growth.
Capital Financing
Attracting Investors
Let’s talk about investors. Imagine you’re thinking about buying a car. You don’t just want the price tag, right? You want to know its history, how it runs, and if it’s going to break down on the road. Similarly, a detailed valuation gives investors the confidence they need to commit their capital. Beyond just the dollar value, a professional valuation will include a business’s growth potential, how steady their income is, its goodwill, and other helpful details.
Securing Loans and Credit
Similarly, lenders like banks require a picture of your business’s worth before offering credit. A comprehensive valuation increases your credibility, helping you secure loans or credit at favorable terms.
Legal and Tax Purposes/Risk Management
Estate Planning
For business owners planning their estate, a valuation helps split the pie fairly and precisely.. It also helps with tax efficiency. If a valuation isn’t completed, descendants can be required to pay higher taxes.
Divorce Proceedings
In divorce cases, a business valuation is essential for splitting assets fairly. It provides an impartial assessment for both parties to agree on, which is invaluable during divorce proceedings.
Tax Compliance and Reporting
No one wants to go to court for taxes. Getting an accurate, professional business valuation early is critical for tax compliance and reporting. Ensure your business is paying its fair share so that you’re in line with tax law.
Employee Stock Ownership Plans (ESOPs)
Implementing Employee Incentives
For companies offering stock options as part of an employee benefits package (woohoo!), a valuation helps determine the market value of the shares. This helps employees know they’re being rewarded fairly, avoiding legal trouble, increasing worker motivation, and promoting a sense of ownership.
Succession Planning
A good business valuation can help you plan for when it’s time to pass the torch. It keeps things smooth for your successor and promotes long-lasting generational wealth.
The Role of Professional Valuators – The Pros
Accredited in Business Valuation (ABV) Experts
After all that, let’s talk about some people who can help navigate this – professional valuators! Hiring a professional with the Accredited in Business Valuation (ABV) designation ensures that your valuation is conducted by someone with specialized knowledge and experience. To get this credential, applicants need to meet a minimum education level, pay a fee, and pass an exam. Other good credentials to watch out for are ASA, CFA, CBA, and CVA, which all come from trusted organizations.
Why Hire The Pros?
You wouldn’t try to do your own hip replacement, right? Likewise, a professional valuator brings greater objectivity, skill, and credibility to the valuation process. They can navigate complex valuation issues and provide insights that go beyond numbers. Calling one up before it becomes necessary (such as in a divorce, a legal challenge, or other emergency) can give you a massive step up.
To Wrap Up…
A business valuation is more than just a number. It’s a vital tool that empowers you to make informed decisions, grow in the gaps, attract investment, and plan for the future. Beyond that, remember not to only do it once. Just like a dental check-up, regular valuations are key for maintaining the health of your business. They keep you informed and ready to seize opportunities as they arise.
Ready to Jump In?
If you’re curious about how a valuation could benefit your business, explore our resources on valuation techniques! Or better yet, reach out to our professional valuators who can give you the insights you need to succeed.
Remember, understanding your business’s value isn’t just knowing a number—it’s about taking control of your company’s future. So why leave it to chance? Get started with a professional valuation today and set yourself up for success.
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