If you’ve ever seen the reality TV show Shark Tank, you know that deals are made (and broken) on the determination of a company’s value. An accurate valuation, just like a property appraisal, is an art and a science. Valuations are subjective and quantitative, and most owners need them when preparing for a sale. However, they’re also necessary for other situations, such as:
- Transactions like buy/sell agreements, fairness opinions, financing, and exit planning
- Tax reporting scenarios such as charitable donations, C-to-S conversions, 409(A), and gift/estate taxes
- Financial reporting (goodwill impairment testing, IP, portfolio valuations, purchase price allocations, and derivatives)
- Litigation in the form of bankruptcy, economic damages, fraud lawsuits, and marital disputes
Here, you’ll learn five important facts about business valuations, and you’ll learn how an accurate valuation will improve your company’s standing and provide you with a clearer road map for the future.
It’s Crucial to Consult an Expert in Your Industry
Although a valuation firm, local accountant, or investment banker can provide a business valuation, the right choice for your company depends mostly on why you’re seeking the valuation in the first place. For instance, a valuation for an employee stock ownership plan or ESOP would have different requirements than one done for the purposes of investment banking. To get an accurate valuation, you’ll need to find someone who not only crunches numbers but also has industry expertise. With authentic guidance, you may see your company increase in value.
You’ll Need to Learn About Your Competitors
An accurate valuation will tell you where you stand as far as competitive advantages are concerned. As a business owner, it’s your job to know what sets your company apart from your competitors’. By looking at where comparable companies are trading, you can gain valuable insights into your own business and learn where to make improvements.
Valuations Allow the Evaluation of a Company’s Growth Potential
A traditional valuation model looks at a profit, net income, and revenue before it considers taxes, interest, amortization, and depreciation. In most cases, it also includes a five-year forecast. Your company’s growth potential comes from its market share and the market’s overall size, and it depends on factors such as competitors’ entry barriers.
It’s Important to Consider Qualitative and Quantitative Indicators
When seeking a business valuation, you’ll need to ask questions such as:
- Am I in a fast- or slow-growing sector?
- Will I need to make significant investments to see continued growth?
- What sort of capital will I need to set aside in the future, and how will that affect the company’s value?
It’s equally important to consider the company’s leadership during the valuation process. If you’ve got a great team managing daily operations, you’ll be able to command a much higher value.
An Understanding of Key Risks
While business valuations typically focus on the positives, they should also point out things that may reduce a company’s value. For instance, a famous chef’s restaurant could face key-person risks if it’s sold to someone else. Insufficient marketability and liquidity adversely affect a business’s value. Here, you’ll need to decide whether your company may gradually become obsolete because of changes in consumers’ preferences.
As vital as business valuations are, they’re a poor substitute for actual offers. Once your company is up for sale, the price a buyer pays may (or may not) be in the valuation range, depending on various market factors. No matter your reasons for seeking a valuation, considering the above factors will provide you with a snapshot of your company as it stands, as well as solid predictions for the future.