If you are looking to sell your company or have received an offer for a merger or acquisition, you may need to know how to value a company. It is important to know the true value of your company well in advance of putting it on the market to give you time to increase its worth.
Knowing how to value a company is key to ensuring you do not get a bad deal. Knowing your company's valuation numbers inside and out can also help you to negotiate a higher selling price when you decide to pull the trigger and sell your company for a healthy profit. At the end of this article, you will learn what a company valuation is, why you need to perform one, and how to calculate to ensure you get a fair deal when you sell your business or look for investors.
What Is Company Valuation?
Knowing how to value a company allows you to come up with a company valuation, which is useful in many circumstances. We will dig deeper into this in a minute. Put simply, a company valuation is an estimate of a company's economic value used to determine the selling price of a company. Depending on why you need a company valuation, it may be based on fair market value, investment value, or intrinsic value.
Is There A Need For Company Valuation?
There is absolutely a need to know how to value a company. A company valuation is a significant factor in how much funding a business can receive when requesting a loan, be it a start-up or existing company.
Better Knowledge Of Company Assets
Part of learning how to value a company is to know how not to value a company. Do not use estimates when completing the assessment of your business valuation. Specific numbers are required to know if you have adequate insurance coverage, how much of your net profit needs to be reinvested in your company rather than paid out to owners, and how much you need to sell your company for to make a comfortable profit.
Understanding Of Company Resale Value
Perhaps the most important reason for knowing how to value a company is to know the true value of the business. Knowing this number well in advance of when you plan to put it on the open market will allow you to take steps to improve the resale value. Knowing your company's business valuation will also help you negotiate a higher selling price. Negotiate your price by using black and white numbers provided by a valuation firm and statistics relevant to your industry and local market if you are selling a small, local company.
Obtain A True Company Value
There is much more to an accurate business valuation than balances of cash accounts, total asset value, and stock market value. This is where a reputable valuations company comes in, but it is important you understand how they arrive at their numbers to ensure you are not low-balled. A business valuation is a major factor in determining if it is feasible for you to sell your company in the open market or not.
Calculate your company's value annually to give you a quick snapshot of how your income and business is growing over the course of five years. Prospective buyers will want to see your company has grown steadily year-over-year.
Better During Mergers Or Acquisitions
Knowing how to value a company puts your company in a better position when facing an acquisition or merger so you do not get sold short during negotiation. Go into the acquisition meeting knowing the total worth of your company, your total asset withholdings, how it has grown to this point, and how it will maintain its growth in the future.
If you know how much your company is truly worth, you can reject any bad deals or insist on entering negotiation mediation. Do not allow a reputable, well-known valuation determination service to undervalue your company's value significantly. Negotiating and explaining how you got to your numbers can allow both parties to come to a comfortable agreement.
Access To More Investors
An accurate company valuation, obtained by a solid understanding of how to value a company, allows you to seek funding for your business from investors. To increase your chance of success, create a valuation projection so they can see how their money will be spent and how it will generate revenue so they can see a return on their investment.
Investors want to see that their investments will allow the company to increase its value by putting money into more raw materials, inventory, or R&D to take the business to the next level. A projected valuation is particularly important when a business seeks investors to avoid financial ruin rather than to finance company growth.
How To Value A Company
The steps for how to value a company are simple as long as you have all the required information. If you have a good bookkeeper or financial accountant, this information should be an e-mail away. You can either plug your company's financial information into a business valuation calculator or calculate it yourself in three simple steps. First, calculate seller's discretionary earnings (SDE). Next, find out your SDE multiplier. Finally, add business assets and subtract business liabilities. The final formula is (SDE) * (Industry multiple) + (Real Estate) + (Accounts Receivable) + (Cash on Hand) + (Other Assets Not in SDE or Multiplier) - (Business Liabilities).
Your company's Seller's Discretionary Earnings are your business's pre-tax earnings before non-cash expenses, interest expense or income, owner's compensation, and one-time expenses that cannot be reasonably expected to repeat in the future. Avoid using income numbers from your tax return to calculate this as you may underestimate actual net revenue due to reporting expenses with the idea to minimize tax burden.
To calculate the true profit of your business, add back one-time expenses, expenses you reported on your tax return that are unnecessary to operate your business, and your salary as the business owner. Other examples of irrelevant expenses include charitable donations, business meals and entertainment, payroll for family members not crucial for your business operations, and bonuses such as personal vehicle insurance, personal travel, or business travel only loosely related to operating your business.
Determine Your Multiplier
Businesses are usually sold for one to four times their Seller's Discretionary Earnings. This number is known as a multiplier or SDE multiple. Determining your business's multiple is based on factors including but not limited to:
The industry standard multiplier is the general value based on average industry business multipliers. Your business's specific multiplier gives you a more specific value based on factors unique to your business. The two most significant factors are industry outlook and owner risk.
If you are trying to sell a business in an industry that is poised to grow in the near future or in an economically sound location, your SDE multiplier will be higher. If the business does not depend heavily on one or more owners and it is easily transferable to new business owners, again, your SDE multiplier will be higher. To estimate your SDE multiple, look at BizBuySell's quarterly report. An appraiser or business broker can help you to personalize your multiple estimate.
Net Business Assets and Liabilities
The third step in how to value a company is to add up all of your business assets, add up all your business liabilities, and subtract your company's total liabilities from its total assets. Deal terms when selling a small business will vary, but they are usually structured as an asset sale. This means the buyer is purchasing the assets that make the business what it is while the seller keeps all liabilities and is still responsible for paying them off.
Tangible assets are physical goods owned by a business that can be liquidated for cash. These include inventory, money your customers owe you, real estate, and cash in bank and investment accounts. Intangible assets are non-physical assets which provide a company with value and help the business to operate such as goodwill, patents, trademarks, and reputation. These are included in your company's multiple because they are usually only sold when you sell the business's assets.
When selling a small business, current liabilities are usually not sold along with the business assets. Instead, the original business owner uses the funds from the sale to pay off the debts. This becomes complicated when there is a line of credit out that the business needs to maintain operations.
When selling your small business, have reports detailing your current debt (debt due within a year), any debt your company is past due on, and how often your company pays its suppliers or utility companies on time currently. Liabilities include all loans and bills such as the employer's portion of health insurance or FICA, unpaid payroll expenses, and loans due to owners.
Learning how to value a company is simple. Calculate your company's SDE, determine your company's multiplier, and calculate your company's net worth. Knowing the value of your company is crucial to ensure you get a fair deal if you are ever at a negotiation table discussing the worth of your business. To back your numbers up, have a reputable company sign off on the accuracy and validity of your numbers.