You may have run your business for 25 years or only 25 weeks; however, there comes a time when you need to place a cash value on it. The problem is that most business owners only have a rough estimate of the company’s value.
Business valuation is a complex and time-consuming process that requires the skill and insight of experienced professionals. This, of course, incurs a cost to hire them, leading lower-middle market business owners to avoid the exercise and ask, “Do I really need a business valuation before selling?”
The simple answer: YES, you do.
Many business owners rate the value of their businesses higher than the market justifies. This overestimation of worth may be due to their emotional attachment to the business. They often overlook the company’s flaws or shortcomings, which potential buyers will not miss and use to reduce their offers.
Estimation refers to a rough calculation, often from insufficient data. Sometimes, an estimate is merely a guess. Valuation is the accurate calculation of worth and the generally accepted process of determining the market value of an asset.
Problems Associated with Estimating Your Business Value
There are several problems associated with an accurate estimation of the business value. Owners face difficulty due to the absence of operating history, unpredictable revenues, and operational losses. If you were to single out one business unit for valuation, you would find several assets interlinked in value. Since values of components are intertwined, assigning a discreet business value to the functionality of each business unit or component is neither practical nor feasible.
For example, one assigns a different value to each component of a real estate purchase, such as location, size, view, etc. Those deemed more desirable or valuable increase the property’s overall value.
The value of a small functionality affects the value of the entire product because you cannot use the product without that functionality. For instance, what is the value of the right front wheel of your car? You cannot use the car without that wheel, right? So, the wheel’s value is part of the car’s value.
Another issue is shared costs when determining the value of a particular feature or component. Business owners often assign business value points to individual components by comparing them to the cost and applying ROI (return on investment). However, the actual cost of implementing one feature is the sum of the costs of implementing multiple features within a system, which cannot be estimated separately.
For example, when estimating the cost of refunding a credit card purchase, you have to include the infrastructure cost of using the card in the first place because the refund does not take place unless someone uses the card. So, not sharing the cost of card processing infrastructure between the purchase and refund results in incorrect ROI (return on investment) decisions.
Assigning business values separately to components or features might be beneficial in some scenarios but not when you want to sell your company. Estimating business value in that way leads you in the wrong direction.
Importance of Correct Baseline Value
You have to know your location now to navigate to your destination. This applies to business as well as road trips.
Whether you want to sell your company or make any other financial decision, an estimate takes you off course. Incorrect data prevents you from achieving your desired exit. Valuation experts accurately calculate your starting latitude and longitudeâ€”the baseline valueâ€”for your company before beginning the exit planning process.
Experts use this reference point to measure and analyze the performance of your business in terms of value, competition, market position, etc. Comparing the baseline value with your exit goals determines the difference, aka the value gap, and which value-creation initiatives are required to attain your desired exit.
A mere estimate does not suffice since the entire exit planning process and the exit strategies are based on the baseline value. Baseline value must be scientifically calculated value using professional business valuation methods.
What Is Business Valuation?
The business valuation process gives you an accurate assessment of a company’s value. To calculate its value, business valuation professionals assess a company based on financial records and other essential documents, competition, market position, potential earnings capabilities, etc.
The complex business valuation process involves different methods and approaches, such as the asset approach, income approach, and market approach. Your valuation advisor will determine the correct business valuation method to calculate the value of your unique business.
The results of the initial business valuation help you to decide if you want to sell your company in its present state and leave money on the table or if you want to increase your company’s value to the level that meets your exit goals so you can achieve your desired exit.
The business valuation exercise gives you an idea of what you need to do before selling the business if you decide to get your desired exit. Your advisors will recommend the proper value creation initiatives, succession planning, wealth preservation, and exit strategies for your business.
Why Should I Get a Professional Valuation Versus an Estimate?
As previously stated, business owners are usually wrong about their business value. Also, estimating business value leads to miscalculation, especially when planning an exit or ownership transition (M&A, gifting, internal transfer, etc.). Working from an inaccurate estimate is a sure recipe for failure in achieving your exit goals.
A professional business valuation ensures that you get an accurate assessment of your company’s current worth. Defining its baseline value puts you on the right track that will lead you to your desired exit with proper exit planning and execution.
How Can Quantive Help?
Business valuation, exit planning, and smooth ownership transition are complex processes that need expert guidance. This guidance relies upon accurate data that can only be collected and analyzed through professional business valuation, not an estimate. Once you have determined that baseline value, you need skilled advisors to help you close the value gap and plan and execute actions for value creation.