Following a discovery process, an advisor will create a realistic picture of what your business is worth. To begin, the next questions you and your advisors should discuss are:
A qualified advisor will help you work through these concerns and develop an exit readiness assessment. This usually starts with a valuation for what your business is worth in today’s market.
From an owner’s perspective, the most important items that stem from a valuation are: the things in your business that you need to keep an eye on, what valuing a business means to you, and what do you net out in your proceeds – meaning, what cash do you walk away with.
So that you understand what valuators look at, you first need to understand the Standard of Value. Fair Market Value is the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller (in an open and unrestricted market). But the confusing part to most people is that indications of value are looked at differently by varying groups of experts. You might get different valuations according to who you ask and how they interpret the data.
It’s important then, to understand the key differences in the three Indications of Value that are commonly used:
When we’re working with clients, one exercise we perform is a ‘Net Proceeds Analysis’ to show how the money flows through, what the taxes are, and what you have to pay back in debt. We also define how it flows through to different shareholders (assuming there’s more than one business owner).
The bottom line here is that you need to make sure you’re comparing apples-to-apples. It’s very possible an Investment Banker will tell you “I can sell your business for $5 million.”And then your Financial Advisor delivers the news that you’re really going to end up with $2 million. They could very well be talking about the same thing, but they’re looking at it two different ways.
There are several varying approaches a valuator might take when placing a value on your business. Each one has their own merit and is usually best determined by your individual scenario – your products/services, industry, company status, etc.
Asset Based Approach. This is considered a floor value. If you’re an operating business, hopefully you’re worth more than the asset-based approach. This is simply the assets on the books minus the liabilities on the books, equals the equity. That’s adjusted for Fair Market Value – so if you have fixed assets, it’s not solely what’s on your financial statement as there may be some adjustments there.
This approach is useful for valuing holding companies and real estate entities, and it needs to be looked at from a valuation perspective. You do need to perform this exercise (even for working capital and the income and market approaches), but for most cases it is not going to be an indication of true value.
Income Approach. This is the more common approach with which most people are familiar. I would estimate that we value companies by using this approach for 80% of our business valuations for operating entities. And generally speaking, this is how most people evaluate the business.
Market Approach. There are a few ways to handle a Market Approach.
This method isn’t used often because you need to obtain recent transactions of comparable-sized companies that do comparable-type things. I’d say maybe 20% of the time we are able to come up with companies that would have indicative values. If we’re able to do it, it’s very suitable – but the process is often problematic in being able to come out with definitively comparable transactions.
If you own a very large, private company, this method might make sense. But for the majority of privately-held companies, to make that kind of a comparison is very challenging.
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