Business Value and Its Impact on Sale Price
In the world of business acquisitions, the sale price of a company is not a number pulled out of thin air; it reflects the company’s intrinsic value. The value that for most entrepreneurs have poured decades of hard work to build and nurture. This value is meticulously calculated using various valuation methods that consider the company’s financial health, market position, and future earning potential.
Most owners have a gut feeling about the value of your enterprise. However, the worth of their company usually is not crystal clear—it’s not just about the numbers, but what it represents: their passion, their legacy, and their future. Therefore, it can be an unpleasant surprise when an expert provides a current valuation. But determining your business’s worth is easier said than done.
Business valuations are often misunderstood. What makes your business truly valuable? The answer to these questions could be the key to maximizing the bottom line and making it an attractive investment that could be sold for profit.
Prospective buyers consider various factors, such as the viability of the business, quality of goods and services, intellectual property, customer base and the talent pool of employees and key players. From a buyer’s perspective, building a business with high value ensures a higher price than the market may suggest.
According to Harvard School of Business, a company valuation, also known as business valuation, is the process of assessing the total economic value of a business and its assets. During this process, all aspects of a business are evaluated to determine the current worth of an organization or department.
To help, here’s an overview of various business appraisal methods that can give business owners contemplating a future sale a leg up so you know your current value, if there is room for improvement, and how you can further improve your attractiveness to prospective buyers.
1. Book Value
Book value is straight forward, yet it is not completely reliable to some appraisal experts. To calculate book value, start by subtracting the company’s liabilities from its assets to determine the owners’ equity. Then exclude any intangible assets. The figure you’re left with represents the value of any tangible assets the company owns.
2. Discounted Cash Flows
Another method of valuing a company is with discounted cash flows. Discounted cash flow analysis is the process of estimating the value of a company or investment based on the money, or cash flows, it’s expected to generate in the future. Discounted cash flow analysis calculates the present value of future cash flows based on the discount rate and time of analysis.
3. Market Capitalization
Market capitalization is one of the simplest measures of a publicly traded company’s value. It’s calculated by multiplying the total number of shares by the current share price. This technique only accounts for the value of equity, while most companies are financed by a combination of debt and equity.
In this case, debt represents investments by banks or bond investors in the future of the company; these liabilities are paid back with interest over time. Equity represents shareholders who own stock in the company and hold a claim to future profits.
4. Enterprise Value
The enterprise value is calculated by combining a company’s debt and equity and then subtracting the amount of cash not used to fund business operations.
5. EBITDA
EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, is a popular metric used to assess a company’s operational efficiency without accounting decisions and tax environments. By focusing on the earnings from core business operations, EBITDA provides a clearer picture of the company’s profitability and cash flow generating ability.
This valuation metric is very commonly used and is particularly useful in comparing companies within the same industry, as it removes the effects of financing and accounting decisions, allowing for a more apples-to-apples comparison. When used to determine a company’s sale price, a multiple of EBITDA is applied, which varies by industry norms and market conditions.
6. Revenue Multiples:
Another common method is the use of revenue multiples. This approach values a company based on a multiple of its revenue, reflecting the market’s willingness to pay for every dollar of the company’s sales. The multiple is influenced by factors such as growth prospects, profit margins, and the competitive landscape.
Assessing Valuation Methods and Sale Price
The choice between EBITDA and revenue multiples and other mentioned valuation methods often depends on the industry and the specific circumstances of the company being valued. For instance, a tech startup with exponential growth but has not made a profit might be better valued on revenue multiples, while a multi generation manufacturing firm in a thriving market with steady earnings might be more accurately valued using EBITDA.
Ultimately, the sale price derived from these valuation methods is a starting point for negotiations. It serves as a benchmark for both buyers and sellers to understand the business value and justify the final agreed-upon price. It’s important to note that while these methods provide a baseline, the final sale price is also influenced by extensive factors such as strategic fit, market timing, and the negotiations of the parties involved. That is why is essential, if you are contemplating a sale of your company whether soon or an exit is the ultimate course, working with an expert is key.
Norris CFO Exit Planning Guidance
Developing an exit strategy is a delicate topic for many CEOs and Owners, yet an important one to carry on the company’s successful legacy. Exit planning should never be done in haste or by chance. Norris CFO Strategic Business Partners can help you prepare an exit strategy “Playbook” that entails the critical steps to plan a successful transition while you continue to work on your business. Start the conversation today.