What’s Your Business Worth: Valuation Models

by Andrew J. Thompson on Nov. 27, 2017

 General Practice 

Summary: What is your business worth? Today? When you’re ready to sell? When you retire? When you want to borrow money? If, God forbid, you had to liquidate the company?

What is your business worth? Today? When you’re ready to sell? When you retire? When you want to borrow money? If, God forbid, you had to liquidate the company?

Knowing the value of your business is important on so many levels. But valuation is subjective. Naturally, it’s typically worth more in the mind of a seller than it ever is in the mind of a buyer – until the buyer becomes the owner, at which point, the valuation instantly increases tremendously!

So what are the techniques that can be employed to tell a potential buyer, broker, banker, tax planner, etc., what the true value of your business would be? No doubt you recognize there are many.

The simplest gauge of valuation is typically the business’ revenues. As a quick, short hand method, this tends to work pretty well much of the time. In many industries, you can take an industry-based multiple of company revenues and get a reasonable approximation of a company’s valuation, just for purposes of discussion or perhaps even to initiate a listing of the business for sale.  It “works” because, as pro forma P&Ls quickly demonstrate, businesses in the same industry tend to have the same expenses ratios and predictions of profitability.

Obviously short hand revenue method has deficiencies. The way businesses within an industry compete is through profit. And competition, being keen, dictates that some businesses within an industry will be more profitable than others, and not always because of higher revenue, but often because they are run more efficiently with less expense per dollar of income. But again, it’s a short hand method, just to get you started, and it has relevance in different situations, depending on the conversation.

A second gauge of valuation is the net assets of the business. This is also a short hand manner for calculating value, but if the numbers recorded for intangible assets are accurate, it’s a highly accurate one. The trick is in valuing the intangibles, which can be very subjective, and the lynchpin to a good valuation of the business is goodwill, which is subjective and can be difficult to calculate. In tech businesses, the intellectual property valuations may be similarly difficult to calculate.  But then there is some measure of subjective in valuing most assets the business owns. Until you’ve employed a professional to give you an opinion of value on the more complex assets, the asset based valuation can remain pretty speculative. All of which is good – for the speculative buyer and seller, and there are plenty in the marketplace today.

While there are many other forms of valuation, perhaps the best is derived from earnings based formulas like EBITDA (Earnings before interest, taxes, depreciation and amortization). This formula accounts for adjustments to reported earnings for expenses that are long term and do not reflect the current state of cash or earnings flow of the business, although they do demonstrate long term consequences of the existing management of the business.

In smaller, single owner businesses, Seller’s Discretionary Earnings, may be used in place of EBITDA calculations. While fairly simple to calculate, the formula tends to yield one of the best possible estimates of what a business would be worth to a new owner of the company on a going concern basis.

There are more sophisticated valuation methods for more sophisticated companies. The means for valuing the intricate pieces of a company themselves can be many and varied. But this gives you a good. quick overview of valuation in the market segment of non-publicly traded companies.

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