Do You Know How Much Your Business Is Worth?
You have spent countless hours working hard to overcome all the challenges a business owner must face. Luckily, all the hard work and diligence you have put into growing your business has likely transformed it into your most valuable asset, but do you actually know what your business is worth? Would you like to know? Read along to find out how business valuations are done and how you can take the first steps to figure out how much your business is worth.
Why Would You Want a Business Valuation?
Business valuations are excellent for obtaining the information needed to:
- Get a good idea of value before deciding whether or not to put your business up for sale
- Determine value while working on a buy-sell agreement or considering the update of your buy-sell agreement
- Consider estate planning needs
- See how the business is performing relative to others in the industry
Bear in mind the valuation report we provide is not suitable to be used with the IRS or to take to your bank to secure potential financing. However, we work in conjunction with a group of very experienced valuation professionals who have recognized the need for accurate valuations without charging the fees generally necessary to cover the potential liabilities associated with a valuation being used for official business or tax matters. We have secured a retainer agreement with this firm to provide business valuations to our clients and we pay the full cost of the agreement.
About Business Valuation
In understanding and interpreting the value of a business, it’s important to recognize there are many different types and levels of value. The most common way to estimate the business value is to use the fair market value on a going concern basis, which assumes 100% interest in both the business assets and equity.
When valuing the entire company (100% control interest), it is necessary to distinguish between the value of “assets” (asset deal) and the value of “equity” (stock deal). In practice, owner-operated businesses are either sold on an “asset sale basis” or on an “equity sale basis” with the purchase agreement reflecting the unique aspects of each scenario.
A variety of factors will determine the chosen mode of sale, with buyer and seller negotiating price and an array of other “terms and conditions,” including the type of sale.
The “asset sale” value will always differ from the “stock sale” value due to the specific group of assets and liabilities that are included or excluded in each format. In determining which estimations of value are of most relevance to the business owner, the reason behind the valuation will typically address this question. Business brokers hired to assist buyers and owners most commonly value businesses under the “asset sale” scenario through multiples of discretionary earnings, while valuations for divorce or estate taxes will be based primarily on the “equity sale” scenario.
The general differences between the asset and equity transaction structure are:
Asset Sale (Asset Value)
Includes ONLY inventory/supplies, fixed assets, and all intangible assets. Excludes all liquid financial assets and all liabilities. The buyer operates from a newly formed legal entity.
Equity Sale (Equity Value)
Includes the assets listed above PLUS liquid financial assets LESS all liabilities (ST/LT). Involves the full transfer of the legal entity including all account balances and current tax attributes.
Naturally, the “value” associated with these two distinct transactions can be substantially different. In practical terms:
Asset sale: The seller keeps the cash and receivables but delivers the business free and clear of all debt.
Equity sale: The buyer is acquiring ALL of the assets and liabilities, on and off the balance sheet.
In the “real world,” there are many variations on these basic structures, e.g., an asset sale might include accounts receivable or an equity sale might exclude long-term debt, etc. They are both “fair market value on a going concern basis” estimates.
In middle-market transactions, it’s also helpful to distinguish between “equity value” and “enterprise value.” Enterprise value is a reflection of the firm’s value as a functioning entity, and it is helpful in that it facilitates the comparison of companies with varying levels of debt.
Which Business Value Conclusion Is Most Important?
The answer to this question depends chiefly upon the purpose for the valuation engagement. If you are negotiating the sale/purchase of a business via an asset sale, then it is the asset value which is most relevant. If you are filing an estate/gift tax return, it’s the equity value which is most important. When evaluating middle-market companies for M&A purposes, both equity and enterprise value will be useful. If your business is rapidly deteriorating and you’re contemplating reorganization, then liquidation value may be of most relevance.
Key Performance Indicators
In the valuation report available to you, it will also cover a number of key performance indicators (KPIs). They are calculated based on an analysis of company-specific data and how that data relates to various industry-specific averages linked to millions of other businesses.
These KPIs are helpful in measuring financial and operational health and growth of a business. The report available to you will clearly show if your company is outperforming, underperforming, or meeting industry standards.
Some of the KPIs included in the report include:
- Cash flow to revenue
- Cash to revenue
- Receivables (conversion)
- Inventory to revenue
- Fixed assets to revenue
- Total debt to revenue
- Receivables to revenue (pre-tax)
- Inventory to income (pre-tax)
- Fixed assets to income (pre-tax)
- Total debt to income (pre-tax)
How We Can Help
Having an experienced financial professional in your corner can make a massive difference when it comes to accurately determining the value of your business. If you would like to take the first step in assessing how much your business is worth, book a free introductory meeting online! We look forward to hearing from you.
Preston Rosamond is a financial advisor and the founder of The Rosamond Financial Group Wealth Management, LLC with over two decades of industry experience. He provides comprehensive wealth management and financial services to successful business owners, corporate executives, and affluent retirees who enjoy simplicity and seek a professional to help them pursue their goals. Preston personally serves his clients with an individual touch, a sincere heart, and his servant’s attitude is evident from the moment you meet him. Learn more about Preston or start the conversation about your finances with him by emailing email@example.com or schedule a call on his online calendar.