Know Your Business's Worth
The true and ever-changing value of your business is one of the most important numbers to have on hand at almost every stage of your business' development.
A business’ value is not a simple thing to determine. Every Tom, Dick and Harry can run a discounted cash flow model or give you a number based on earnings multiples – and charge an arm and a leg to do it.
But no two businesses are the same, and as an owner, investor or financial planner, being able to value and communicate that uniqueness is key to making the right decisions at each stage in a business’ journey.
The problem with traditional methods
The shortest answer to “What is your business worth?” is certainly going to be the Net Asset Value, your business’ assets less its liabilities. But is that the right sale price?
This number doesn’t capture the value of client relationships, the strength and experience of the management team and staff, or the time and effort invested in understanding the key features of the niche that you are servicing – how much are these worth?
Traditional approaches to determining a business value include valuing the future expected cash flows (dividends) that the business would generate and applying a multiple to earnings that is ‘appropriate’ to your business’ industry.
These methods rely heavily on what has happened in the past. For young businesses however, projecting cash flows can be a guessing game and multiples are next to useless.
Companies that command a specific competitive advantage may have positioned themselves in a class by themselves. Even large, professional accounting firms have been known to provide a valuation report using these methods concluding that an enterprise is worth ‘somewhere between R100 million and R400 million’.
Using only traditional methods to value a business is like saying that all accountants are the same and that there is little reason to distinguish between them, or that all rugby players should be judged by the same set of criteria regardless of their position on the field. Utter madness.
The need for the right value
Depending on your interest in a business and your objectives, the business value plays a number of critical roles:
- Buyers and sellers want to ensure that they are transacting at the right price. Their objectives are naturally in conflict, so finding an objective value can be key in progressing negotiations.
- Raising financing means that financiers are going to want to know exactly what they are getting. Negotiating the best terms will rely on a robust and defensible understanding of the business’ value and drivers.
- Executives and management are responsible for ensuring a business’ growth and stability. Knowing the score is the first (necessary) step in deciding what action to take next.
- Business owners and shareholders need to plan responsibly. The business value serves the design of owner protection arrangements (such as buy-sell agreements), business continuity planning, individual wealth management and estate planning.
An important aspect often overlooked by business owners is that the business value is not a static number. Using only the most recent set of financial statements to value a business is like deciding what to wear based on the weather two months ago.
Owners should be constantly updating and monitoring their business value and its drivers, not only considering it when needed or once a year when the financials need to be signed.
The value of the right partner
The right partner, be they your accounting provider or an independent third party, will be able to address all of these aspects and provide a regular, relevant valuation that is specific to your business.
Owners, shareholders and executives alike should all be pushing to ensure that this crucial number is always front of mind and forms a cornerstone to strategic planning and decision making at all levels.
Given the importance, settling for the simple, back-of-the-envelope methodologies is a sure-fire way to sell your business short in more ways than one.
Gareth Watson is an actuary, consultant and co-founder of iBizValue, a firm specialising in business valuations and corporate finance projects for small to medium companies. Having worked at both large and small multi-national companies, Gareth has developed a keen insight into the value drivers for a range of businesses. Contact Gareth at firstname.lastname@example.org.