CHAPTER 2-BUSINESS VALUATION

Lesson 2.1: Business Valuation

EDIT PAGE

IN THIS LESSON

  • We discuss the Importance of an Accurate Valuation

  • Different Valuation Methods

Chapter 2.1: Introduction to Business Valuation

Welcome to the fascinating world of business valuation! In this chapter, we'll delve into the importance of understanding valuation for your business and explore different valuation methods used in the industry.

Importance of an Accurate Valuation

Imagine setting sail on a journey without a map or compass. That's what selling your business without a proper valuation feels like. An accurate valuation is like your guiding star, helping you navigate the seas of negotiation, pricing, and ultimately, securing the best deal possible.

Real-World Implications of Incorrect Valuation:

  • Underpricing: Undervaluing your business can mean leaving money on the table. It can lead to missed opportunities for maximizing returns and achieving your financial goals.

  • Overpricing: On the flip side, overvaluing your business can deter potential buyers, prolong the selling process, and create unrealistic expectations that may never materialize, causing frustration and lost opportunities.

How much do you want to sell the business for?

Let’s start this exercise practically by answering a few questions that should be considered as a sale price is being established or at least the idea of where we believe the sale price should end up. These factors go beyond the numbers and are truly subjective to whoever is attempting to establish the value of the business.

Subjective Pricing Factors include:

  1. Industry outlook (tied to your niche).

  2. Macro-economy- does your business trend with the economy or is countercyclical?

  3. Local economy- Are there big changes occurring in your local economy that could drive revenues and profitability positively? Negatively?

  4. Accepted rate of return based on perceived risk of the business.

    1. Please note that I said PERCEIVED RISK. All of us have unique risk tolerances and as such will view the inherent risk in any business differently.

Lastly, check your price…

  1. How did you arrive at this price? Does it seem reasonable to a potential buyer? Did you weight the subjective pricing factors appropriately?

  2. What did business assets did you include in the sale of the business?

  3. What are some things you would want to keep out of the sale of your business?

  4. What terms would you be willing to offer if it meant getting a higher price for your business?

Always check your work and run the numbers again. Getting a business priced right can be the difference between selling your business timely or putting it on the market and having it sit because it is priced too high and eventually lowering the price to a level that is below your ideal price range to gain interest and potentially get an offer.

In the next lessons, we'll delve deeper into each valuation method, explore valuation models, discuss industry-specific multiples, and equip you with the tools to unlock your business's true value in the eyes of buyers and investors. So, buckle up and get ready to embark on a valuation journey that will transform your approach to selling your business!

Different Valuation Methods

Valuing a business is both art and science. There are various methods used to determine a business's worth, each with its nuances and applicability based on industry, size, and financial performance. Here are some common valuation methods:

  1. Asset-Based Valuation:

    • Focuses on the value of the business's assets, including tangible assets (such as equipment, inventory) and intangible assets (like intellectual property, brand value).

    • Applicable in asset-heavy industries or when valuing distressed businesses.

  2. Market-Based Valuation (Comparative Analysis):

    • Compares the business's financial metrics (such as revenue, EBITDA) and multiples to similar businesses in the market.

    • Utilizes market data and industry benchmarks to gauge relative value.

    • Helpful for businesses with comparable peers and in industries with established valuation multiples.

  3. Income Approach Valuation:

    • Considers the business's income-generating potential to determine value.

    • Includes methods like Discounted Cash Flow (DCF), where future cash flows are discounted to present value, and Capitalization of Earnings, where a capitalization rate is applied to normalized earnings.

    • Suitable for businesses with stable cash flows, growth potential, and predictable income streams.

  4. Hybrid Methods (Combination Approach):

    • Integrates multiple valuation methods to triangulate a more accurate valuation.

    • Combines elements of asset-based, market-based, and income-based approaches to account for different aspects of the business's value.

    • Provides a comprehensive view and mitigates weaknesses of individual methods.

Understanding these valuation methods empowers you as a business owner to assess your business's worth objectively, justify your asking price to potential buyers, and negotiate from a position of knowledge and confidence.