How much is your business worth? That is not a speculative question, or one that should be answered with a “ballpark” guess. Attaching an accurate valuation to a company is a critical part of ongoing business strategy.
Purpose of Business Valuation:
Funding and Investments: If you are setting up a new business and are seeking capital or investors, you may have difficulty showing your company’s potential without a solid history. A business valuation can be beneficial when searching for investments. Valuation may be based heavily on your vision and your overall value in the market segment you are offering.
Sale of Business: As an entrepreneur, if you are planning to sell your business to a third party, it is great idea to set a base line value for the business and develop a strategy to improve the profitability to increase the value as an exit strategy.
Merger, Acquisition & Amalgamation: A Valuation is typically performed when a company acquires another company, is targeted for an acquisition, reorganizes its capital structure, splits up or files for bankruptcy while in liquidation or reorganization. Having a buy-sell agreement in place between multiple owners ensures a smooth transition of a business. Performing a business valuation can help you determine whether the price you are being asked to pay is fair.
Employee Stock Option Plans: An employee stock-ownership plan (ESOP) is an employee benefit plan that invests in employer common stock. ESOPs provide capital, liquidity, and certain tax advantages to those private businesses whose owners do not wish to go public. A valuation must be performed annually for an ESOP. This valuation determines the price per share for the beneficiaries of the ESOP plan. Shares of Employee Stock Ownership Plans must be valued by an independent valuation expert on an annual basis to establish a fair stock price.
Different approaches to a Business Valuation:
Income approach: This determines the value of a business based on its ability to generate desired economic benefit for the owners. It converts future anticipated economic benefits into a single present value amount. Discounted Cash Flow method is widely used method which requires proper selection of the capitalization rate, discount rate and valuation multiples. This approach is generally best suited for established, profitable businesses.
Market approach: This determines the value of a business in comparison to historic sales involving similar businesses. Comparable Company Analysis and Precedent transactions are typically used which requires estimation of pricing multiples. This approach is especially used when valuing public companies (or private companies large enough to consider going public).
Asset approach: This determines the value of a business based on the value of business’s net assets. The idea is to determine the business value based on the fair market value of its assets less its liabilities. This approach is particularly used when valuing asset-intensive companies and distressed entities that aren’t worth more than their net tangible value.
Business Valuation is very subjective. No universal formula exists for all businesses. Therefore, it’s essential to choose a specific method (or methods) over all the possible options depending upon the type of business and other factors.