If you’re looking to value your company you’re either planning to sell or may be looking for investment to grow your business.
It’s essential to accurately estimate the value of your business – if selling; you’ll be clear about the value you expect to get from a buyer. If you’re looking for investment, an investor will look positively on your business if you have provided an accurate valuation. If you’ve ever seen Dragon’s Den, you’ll know how poor valuations can affect an investor’s decision!
There are a number of factors that can affect the value of your business. Some of them are as follows. Externally, the state of the economy is also affecting the value of the company. The similar business of competitors, particularly on how much are your competitors (of a similar size) worth gives the rough surface on the valuation of a company. Whereas internally within the company, such as the company’s finance and this includes historical and project profit, cash flow, and costs need to be taken into consideration. Another thing that is also affecting in regards to any patents or intellectual property that you own. The strength of relationships with customers and how many regular purchases/orders you have are also determining the value of the company. In addition to that, the value of assets and debt within the company will be included. More into internal factor is people (how loyal are the staff? Is the business depends upon your personal skills?) and reputation and brand name, as well as the marketing activity.
The major factor that will affect the value of the business is, and definitely cannot be ignored, how much a buyer is prepared to pay! They’ll use the above factors to influence the price they pay however try not to overvalue the business as this can really put off potential buyers and investors.
In general, you will rarely be able to compare your potential acquisition with a similar transaction. There is little information available on such transactions and they may not even apply to your specific condition s. Also, the terms may be too closely related to a particular sector to be useful.
According to the Canadian Institute of Chartered Business Valuators (CICBV), there are three types of reports, they vary from the most general to the most detailed. Firstly is calculation report, it provides an approximate valuation for initial planning. Secondly is an estimation report, it is ideal for preliminary negotiations, succession planning, and situations involving important issues that are subject to budgetary constraints. Thirdly is a comprehensive report, an appropriate in situations that involve high risks, important issues, or when there are legal proceedings.
To prepare their reports, evaluators look at the facts and financial data, formulate a conclusion, and the possible impacts on the estimated value. They will also add a disclaimer regarding the scope of the mandate, which varies with the quality of the report provided.
To produce a calculation report, the valuator reviews and analyzes the financial information and may meet with management. The estimate report takes the same approach but is more exhaustive. In the comprehensive report, the valuator provides an opinion. It is a more in depth analysis of the business and it reviews namely patents, bylaws, and shareholder agreements; business’ economic situation and sector; market conditions and the competition; clientele and any contracts, backlog of orders; suppliers contracts and commitments; visit to the business; financial and forecast data and rationale for the choice of discount and capitalization rates using accepted financial models
Basic valuation principles for company valuation, firstly, step in the process of establishing a price consists of determining the fair market value of the business. The three main valuation principles are (1) value is dependent on expectations, (2) value is dependent on future cash flows and (3) value is dependent on tangible capital assets.
There are two basic ways or methods of determining the value of a business, namely asset-based and earnings and cash flow.
- Book value: Company’s net worth, which is equal to assets minus liabilities. What is shown in the financial statements
- Liquidation value: Assumes that the business sells all its assets, pays off all its debts, including taxes, and distributes the surplus to its shareholders
- Earnings and Cash flow
- Discounted cash flow: Value is based on the future cash flows of a business
- Going concern value: Assumes that the business will continue operating and compares the current cash flows with future inflows to make projections
Some of the most common techniques used to calculate a business value include:
- Capitalization of typical net earnings: A value can be attributed to future earnings resulting from the acquisition. To obtain the going concern value, a capitalization multiple is applied to these earnings and non-operating assets are added.
- Capitalization of typical cash flows: The same as above with the exception that cash flows, rather than earnings, are capitalized.
- Discounting of expected future cash flows: Consists of determining the most likely future cash flows and discounting them at the valuation date.
- Determination of adjusted net assets: Liabilities are subtracted from the determined fair-market value of the assets. It is used for businesses, such as those in the real estate sector, whose value is asset-related rather than operations-related.
There’s nothing simple about estimating the value of a business you want to acquire. Valuating a business is not a simple exercise, nor is it an exact science. It simply provides a theoretical value that will give you an idea of the fair price to pay for a business. It is advisable that you mustn’t rely only on the judgment of your accountant or of the seller. It is recommended that you have an expert, who specializes in business valuations, produce an independent report.