Business Valuation Is Not Just A Number, It's A Story
You're reading Entrepreneur India, an international franchise of Entrepreneur Media.
To a majority of business owners around the world, the most important business performance metric is the top line or bottom line on their income statements. As long as they can see the former growing moderately Y-o-Y or the latter in the green, they can get a night of peaceful sleep.
I have asked many business owners the market rates of their property, their cars or even the current watch/bag they wear and carry and mostly received an immediate response with a close enough estimate. However, when it comes to asking them the price of their single largest asset, their business, the answers have rarely been certain.
Seldom do business owners spend time and resources to dig in deeper to see the bigger picture for their entities. In the midst of all the ‘business-as-usual,’ they forget asking themselves the main question — “What’s my business worth?”
Why Is This Number Relevant?
The most common question I get from most business owners is this: “Why is a business valuation important if I am not looking to sell my company?” — A fair question, I’d say.
Business Valuation is an 8 billion dollar industry (in the US alone) with less than two per cent of businesses engaging an appraiser to get them one on a regular basis. The other 98 per cent don’t.
And here is why. A certified business valuation is time-consuming, expensive, intrusive and complicated. Taking all of these objections into consideration, it’s no surprise that business owners wait until an event requires them to get a valuation performed on their business.
However, it’s important to understand that a life event (e.g, lawsuit, divorce, retirement, downsizing, etc) will probably be the most inconvenient time to get a valuation completed. It’s similar to saying that you’d want to plan for your retirement the day you actually retire.
There are many more reasons that necessitate a business valuation.
An incoming external investment, an internal restructuring, an acquisition or a share swap, separation of partners, a shareholder’s divorce, creation of ESOPs, tax & insurance planning, succession and retirement planning are some to highlight a few.
Every Small and Medium Enterprise (SME) owner needs to make one or more of the above plans during the business’ running tenure. Wouldn’t it be better to be well-informed rather than being caught by surprise (shock, in most cases) when you are told what this number is at the negotiation table itself? Wouldn’t they perhaps wish they had monitored this value frequently to obtain better, more favourable deals? Wouldn’t they be looking onto their advisor’s side wondering why they weren’t told so?
When Should You Start Valuing Your Business?
This is another common question from business owners. The answer ideally is, right from the very beginning.
No matter which stage one’s business is at, in terms of revenue, product, number of employees, partnerships, branding — this single number has the power to give the owner a sense of direction and motivation to run the extra mile. It enables them to modify their vision for the future, ability to deploy strategies to move to the next level and even hope to keep going when their financial statements aren’t telling them the ideal story.
At the start-up stage, key decisions about operations, sales, marketing, product could each lead to a different valuation in the future. It’s imperative to work bottom up, evaluate future projections and think about valuations, as investors surely will.
For most one-man teams, which have probably moved on from the start-up stage, valuation can be pivotal in matters relating to expansion.
For businesses that have moved onto a team of a few people and have started generating more than just ‘month-to-month existence’ returns, valuation can help the business take on some investment, reinvest its capital sensibly, do an acquisition or structure an incentives program for it’s employees.
And finally, for a successful business with stellar y-o-y performance and with a team of more than 50 odd people, a business valuation will help the owner/manager/leader to make informed decisions with any of their shareholders who would often refer back to their financials at this stage.
How Should You Value Your Business?
Every situation, every event in a business would require a different perspective on it’s valuation. For example, if one is looking for an exit, the past and present (equity) should drive the valuation estimate. On the other hand, an external investor would probably want to look at the future and potential of one’s business (enterprise).
Moreover, there are additional questions on the micro and the macro front of one’s business that need to be answered.
At the micro level, owners would need to take a deeper look into their revenue generation, business profitability, stability of cash flow, competitive advantage of the business and reliance of the business on it’s owner.
At the macro level, they would need to dig into the industry lifecycle in which their businesses operate.
In terms of valuation methodologies, there are three widely accepted ones that should be noted:
- Income approach seeks to transform measures of profits or cash flow into estimates of value by way of multiples, capitalization rates and discount rates.
- Market approach involves an analysis of the recent sales of comparable businesses.
- Rules of thumb include simple but often powerful valuation methods regularly used by market participants. Some business types are bought and sold almost exclusively by way of these industry- specific rules of thumb.
If financial advisors to these SMEs can take on the responsibility of better informing their clients about their businesses, answer these simple ‘why, when, how’ questions for them regularly and get them access to this traditionally expensive metric. We would be able to see SMEs perform better and maximize value over time.
To highlight a few: 98% of any economy today is being driven by the performance of SMEs, 7.7 million SMEs are about to change hands in the next 10 years and 7 to10 business owners plan to fund their retirement with their business’ sale amount.
It’s simple what we at BizEquity are trying to preach: “Knowing the price of one’s business today can help one modify their strategies, so they can reach the optimum level over time and narrate a beautiful valuation story for their business tomorrow.”