By Liz Briggson and Jacob Helwick
Organizational planning is foundational to achieving sustainability and long-term success. A business valuation can support this initiative by defining objectives and identifying key strengths, areas for improvement, and meaningful opportunities.
Matt Bakker, President of Landscape Design Services, obtained a business valuation from Adamy Valuation for his family-owned business and provided the following feedback:
“Even if you are not planning on selling your company, the things that make a company more valuable to a potential buyer make the company more valuable to the current owners. The process of obtaining a business valuation helped us to identify key value drivers and to focus on how we can improve the value of our company to our family shareholders.”
So how does one determine the value of a business? The qualitative and quantitative process of business valuation provides the answer. Cash flow, comparable business sales, and asset values are the most common approaches to deriving business value.
The worth of a business can be measured by the present value of its future cash flows. We call this the income approach. Often, a financial forecast is developed over a finite period and extrapolated into the future. A discount rate is then applied to arrive at a price an investor would pay today for the asset.
Intuitively, investors will demand a higher discount rate, or rate of return, for a riskier asset. Building a discount rate involves qualitative considerations such as management team strength and quantitative measures such as historical stock market returns. Rates of return and value hold an inverse relationship (i.e., a higher discount rate leads to a lower valuation, all else equal). Therefore it is important for business owners to use the valuation to identify areas of risk and ways to proactively mitigate those risks.
Comparable Business Sales
Much like real estate appraisers, business valuation professionals must pose the following question: “What are investors paying for a similar asset?” By analyzing businesses that have previously transacted, sales and earnings multiples can be extracted to infer the value of our subject business. To accomplish this, valuation professionals must first find businesses that serve similar markets, operate in an aligned industry, and/or have a comparable financial profile, among other considerations.
The asset approach is simply a sum of the parts, such as inventory, equipment, and real estate, after adjusting the reported balance sheet figures to market. While this approach is appropriate for real estate and other investment holding companies, its relevancy for an operating entity is limited to situations where a business is significantly underperforming its full potential.
Understanding Your Financial Position
Many business owners hold a significant portion of their net worth in their business, which should be carefully considered when planning for the future. A business valuation does more than provide a snapshot view of company value. Nick Adamy, Managing Director with Adamy Valuation, echoes Matt Bakker’s sentiments, “The business valuation process can help you maximize value by uncovering key value drivers specific to your organization.” A business valuation provides owners with insights to positively impact cash flow and reduce risk in a way that improves their financial position for the future.
Next week we will look at the importance of proactive estate planning for business owners
For additional resources, we recommend:
- Planning for the Exit Part 1: Are You Ready to Sell?
- Value Driver One – Value Driver One: Higher Profits and Cash Flow | (adamyvaluation.com)
- Value Driver Two – Value Driver Two: Lower Risk | (adamyvaluation.com)
- Value Driver Three – Value Driver Three: Higher Growth Potential | (adamyvaluation.com)