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example, if your home is already valued at the high end of the houses in
your neighborhood, it might not be wise to invest in a half-million-dollar
renovation. Or, if you calculate that you have more than enough cash to
fund your retirement, you may be ready to consider some gifting
strategies.
Similarly, a business valuation can help you improve the way you
manage your business. The bottom line is that while most business
owners start down the valuation road only when they begin
contemplating the big sale, there are many reasons why a business
valuation is good business. A business valuation can help you achieve
the following:
The same is true for sales of small businesses. If you have a firm
idea of what your business is worth, you are more inclined to price
it attractively for interested buyers. On the flip side, you may wish
to merge with or acquire another company. Having an up-to-date
business valuation can allow you to move faster to take advantage
of these opportunities.
Inform estate planning. In many cases, the value of a business
represents a sizable percentage of your net worth, so working on an
estate plan is impossible without an accurate valuation. A valuation
is particularly important if you have children who wish to continue
to be involved with your business.
Protect your family. If something happened to you, a business
valuation could help your family deal with the potential sale or
dissolution of the business. Knowing the value of your business
could also be important in divorce proceedings or if you wanted to
buy out a partner and bring in one of your children.
The value of the business consists of not just the Price (i.e., the amount
to be paid for the business) but also the associated Terms and the Deal
Structure. Different values for a business can exist because of different
operating assumptions, deal structures, payment terms, etc., not due to
use of different valuation methods.
A few of the value drivers are:
1) Future Performance
2) Financial Leverage
3) Financial Return Expectation
4) Cash Flow, Not Profits
5) Deal Structure
6) Asset Type
7) Exit Strategy
It may seem surprising at first that the valuation results are influenced
by your need for business valuation. Isn't business value absolute? Not
really. Business valuation is a process of measuring business worth.
And this process depends on two key elements: how you measure
business value and under what circumstances.
In formal terms, these elements are known as the standard of
valueand the premise of value.
Once you know how and under what conditions you will measure your
business worth, it is time to gather the relevant data that impacts the
business value. This data may include the business financial
statements, operational procedures, marketing and business plans,
customer and vendor information, and staff records.
A look at the customer list quickly shows where the business gets its
revenues. Businesses that do not rely on a few large customers for
most of their business sales tend to command a higher selling price.
Let's say that the business enjoys an exclusive distribution agreement
with a major vendor, a key competitive advantage. If this agreement
can be transferred to the business buyer, the business selling price is
likely to be higher.
Skilled and motivated staff is essential to business success. Not
surprisingly, if experienced long-term employees stay with the
business after the sale, the selling price is likely to reflect it.
Some of the information will provide immediate and useful parameters
to determine the business value. Other parts of this data, notably the
company's historical financial statements, require adjustments to
prepare inputs for the business valuation methods. We discuss the
financial statements adjustment process in the following sections.
Asset approach
Market approach
Income approach
Inventory
FF&E
Approach
Valuation
Method
Value
Weight
Weighted
Value
Market
Comparative
business sales
$1,000,000
25%
$250,000
Income
Discounted Cash
Flow
$1,200,000
25%
$300,000
Income
Multiple of
Discretionary
Earnings
$1,350,000
30%
$405,000
Asset
Asset
Accumulation
$950,000
20%
$190,000
The business value is just the sum of the weighted values which in this
case equals $1,145,000.
While there are no hard and fast rules to determine the weights, many
business valuation experts use a number of guidelines when selecting
the weights for their business value conclusion:
The Discounted Cash Flow method results are weighted heavier in the
following situations: