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What You Should Know About Business Valuation

Business Valuation

If you own a closely held business, have you ever stopped to think about how much money your business is worth? Many owners haven’t, which is a little surprising when you consider that a successful business may be the most valuable asset they possess.

Even if you have thought about your company’s value, you may not have gone through the exercise of a formal business valuation. It’s important to do this at some point in your business lifecycle — especially if you plan to sell your business at some time in the future to generate funds for retirement or to start another business.

Different Perspectives on Value

As you begin the process of valuing your business, it’s important to remember that “beauty is in the eye of the beholder.” In other words, you will probably see your business in a different light than those outside the company — who haven’t poured their blood, sweat and tears into it for years — will see it.

Buyers view businesses not through an emotional lens, but through the lens of numbers and data that will determine their potential return on investment (ROI) if they purchase your company. They put little if any value in the “sweat equity” you’ve invested in growing your business and are more interested in how much they can increase future cash flow and earnings, or EBITDA as it’s often referred to (this stands for Earnings Before Interest, Taxes, Depreciation and Amortization).

The best way to narrow the gap between differing opinions of what your business is worth is to hire a trained appraiser to perform a professional business valuation. An appraiser will identify all of your business assets and place a value on them. These include both tangible assets like cash, accounts receivable and inventory and intangible assets such as patents, customer lists and your industry reputation.

The appraiser will also look at other factors that could affect your company’s value, such as:

  • Your company’s operating history,
  • The depth and strength of your management team,
  • Your competitive position in the industry,
  • The outlook for your particular industry, and
  • Broad economic conditions in the U.S. and overseas if yours is an international business.

Different Approaches to Valuation

There are several different approaches appraisers can take when valuing a closely held business. For example, the market approach considers the value of other businesses that are similar to yours, kind of like homes are usually valued based on the sale prices of similar homes (or comps) in the same area. Conversely, the asset-based model takes a more mathematic approach by subtracting your business liabilities from the fair market value of your assets to arrive at an adjusted net asset value for the business.

The main thing a buyer will be looking at when assessing the value of your business is the potential of your current business assets to increase future cash flow and earnings. Put another way, a buyer will try to determine the present value of future ownership benefits — specifically, improved future financial performance in the form of higher EBITDA.

Therefore, the greater the risk that future financial performance won’t live up to current projections, the less value a buyer will ascribe to your company. So it’s important to focus on reducing risk prior to having a business valuation performed for sale purposes, including the following risks:

  • Financial risks: How certain are your projected future earnings and cash flow? Is a high percentage of revenue concentrated with just one or a few large customers?
  • Market risks: How much competition does your company face, what is your realistic future market share, and what is the projected future demand for your products or services?
  • Management risks: How capable are your managers of keeping things running smoothly after you depart — and are they incented to remain with the company long tem?

Determining Where Things Stand

Even if you’re not planning to sell your business anytime soon, it may still be worthwhile to have a professional business valuation performed. This way, you’ll have a good understanding of where things stand now — and more importantly, steps you can take to increase the value of your business between now and the time you do want to sell.

Please contact us if you have more questions about valuing your closely held business.

The commentary is limited to the dissemination of general information pertaining to Frontier Wealth Management, LLC’s (“Frontier”) investment advisory services. This information should not be used or construed as an offer to sell, a solicitation of an offer to buy or a recommendation for any security, market sector or investment strategy. There is no guarantee that the information supplied is accurate or complete. Frontier is not responsible for any errors or omissions, and provides no warranties with regards to the results obtained from the use of the information. Nothing in this document is intended to provide any legal, accounting or tax advice and Frontier does not provide such advice. This information is subject to change without notice and should not be construed as a recommendation or investment advice. You should consult an attorney, accountant or tax professional regarding your specific legal or tax situation.