Whether you are thinking of selling your business in the near future or are interested in taking on outside investors, it is crucial that you have an accurate valuation of your business. In order to value your business, you’ll need to apply standard valuation methods as well as take into account the circumstances of different buyers. While there are no fixed rules or formulas, their are common practices and the value of your business will always be what you are willing to sell it for in addition to what the potential buyer is willing to pay.
There are a few methods that are used by industry practitioners to value the worth of a company that will ultimately consider a number of details to help you understand the worth of your business.
Valuation Method #1: Comparable Analysis
One of the more common valuation methods is to take a look at a comparable company that was recently sold or other similar businesses that have known purchasing value. You’ll find a multitude of resources at annual industry conferences or other events to help discover the selling price of similar companies within your industry.
A common problem with this method is that it often leads to an uneven comparison between companies. Keep in mind that you need to be realistic when comparing your company to others; you can't compare your small local business for instance with a fortune 500 counterpart.
Valuation Method #2: Asset-Based Valuation
This approach considers your business’s total net asset value, minus the value of its liabilities. There are two ways to approach this method:
For a business that does not have plans to sell their assets in the near future, the going-concern approach should be used when developing an asset-based valuation. The formula involved utilizes your business’s current total equity, or assets minus liabilities.1
This approach is based on the assumption that your business is coming to an end and the assets are going to be liquidated. The value of your company’s assets will likely be lower than usual, considering the liquidation value usually amounts to be much less than fair market value.
A sort of urgency is utilized with the liquidation value method that other valuation methods may not take into account.
Valuation Method #3: DCF (Discounted Cash Flow) Analysis
This analysis is an approach in which an analyst will forecast the cash flow of the business and discount it at the firm’s Weighted Average Cost of Capital (WACC).2 A DCF analysis is performed by creating a financial model and requires an extensive amount of detail. Of the three approaches, this method requires the most assumptions and often produces the highest value. The effort required to prepare a DCF model often results in the most accurate valuation.
For larger companies, the DCF value is commonly an over-arching analysis, in which different business units are presented individually and ultimately added together.
Consider a Variety of Methods
Ultimately, the value of your business will involve what you are willing to sell it for combined with what the current demand for a business like yours in the market. While there are a number of valuation methods to consider, it’s important to keep in mind that there may not be only one solution. Instead, you may want to consider utilizing a combination of business valuation methods in order to set a selling price. By working with a financial professional that specializes in business valuation, you'll be much more likely to sell your business for the best price.
Beacon Hill Private Wealth is an independent, fee-only, fiduciary investment advisor providing evidence-based wealth planning solutions that simplify our clients' financial lives. Founder Tom Geoghegan, CFP®, MBA is also a member of the National Association of Personal Financial Advisors (NAPFA).
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