Why Your Business Valuation Could Be The Most Important Thing You Do
Valuing anything that matters – businesses, products, contracts, people – is a risky business. Settle too low or too high and you lose out – or worse. Often, a business' valuation receives less attention than other pricing exercises, despite the potentially severe downsides.
Nearly any serious entrepreneur can recite their pricing model in their sleep and detail the margins on each line of business to the third decimal place. But can they do the same for their business value?
The cost of mispricing a business in any of these arenas can far outweigh all the careful rigour applied to setting those product-price margins, so why doesn't it receive the same level of attention?
This article outlines just a handful of the scenarios in which not having an up-to-date business value can be damaging to companies and shareholders.
Let me buy in…
Three shareholders pour their blood, sweat, tears into a new business for three years. A large bank approaches them and offers R2 million for a 51% stake in the company. Happy days.
But is that a fair value to hand over control of the company? Shareholder one and two have both lent the company R1 million – how does this factor into the price? If your counter-offer is R8 million, will you be laughed out of the room? If that bank sells their 51% for R6 million in three months' time, then the shareholders should certainly have negotiated up… but by then it's too late.
Negotiations are difficult at the best of times. Starting on the back foot certainly won't make them any easier though. Understanding the business value, its drivers and the balance sheet structure is core in being able to grapple with an offer of any kind.
The king is naked!
Five shareholders each hold 20% of a company. Five years ago, they valued the business at R10 million and took out insurance as part of a buy-sell arrangement.
Two of the shareholders pass away in a car accident, meaning that the other three shareholders are obliged to buy the deceased's shares.
But no one updated the buy-sell arrangements. The insurance pays out R10 million, but the company is now revalued at R100 million.
The remaining shareholders need to find R10 million each. If they cannot find the funds quickly, an unknown external shareholder may buy the shares at a discount and own 40% of the business – and this is on top of having lost two key people.
Reviewing the business value and updating the buy-sell and other business protection plans is a simple exercise. Understand the changes in value and ensure that plans and policies are updated accordingly. Neglecting to make this a regular process can leave business owners very exposed, very quickly.
Double or nothing
Fund raising can be an intense exercise. Not only can the negotiations be tough, but financiers will hold you to task if reality deviates from the picture you painted during those pitches.
Overconfidence could see you raising funding on promises of a return that you simply cannot sustain and under selling your business could see you raising expensive funding, making it harder to attract future investors.
Understanding your business and its value proposition allows you to present a realistic and sustainable picture to financiers. One bad deal can mean the end of a business.
The value of the right value
If someone asks to buy your car, you aren't going to respond with "well, it's green" – you're going to give them a price, a Rand number.
Sure, that price can be supported by fuel efficiency, access to parts, odometer readings (and perhaps colour), but the price is the starting point for discussion.
If you own a business (car) now, it is possible that you will be owning another business (car) in the future – make sure you are getting the right support to understand the value of your business and plan accordingly.