Business valuation is necessary when business owners are looking to sell their businesses. It allows the owner to estimate the company’s worth and put an accurate price tag on it during the negotiations. An independent appraiser must do business valuation; however, understanding the process is essential to feel confident in understanding the worth of your business. Even if you don’t want to sell your business any time soon, carrying out a valuation for sale can help structure the business’s plans and exit strategies. This article will discuss why you need to value your business, how to value business for sale, and different business valuation methods for sale.
Business valuation for sale
When business owners are looking to sell their business, how do they put a price on it? Professionals utilize several business valuation methods for sale when providing a thorough business valuation. A valuation for sale can guide owners to negotiate through the procedure to get a fair price for their business.
Understand business valuation
The process of estimating a company’s present value while considering all of its facets involves doing a business valuation. A review of a company’s management, financial structure, the potential for future profits, or the market worth of its assets may be included in a business valuation. Depending on the evaluator, the company, and the industry, different tools may be employed for a business valuation. Examining financial records, discounted cash flow projections, and similar company evaluations are common methods for valuing businesses.
Businesses often conduct a business valuation when owners wish to sell all or part of their operations, combine with another company, or buy another business. Additionally, business valuation is crucial for tax reporting. The Internal Revenue Service (IRS) mandates that a company’s fair market value be used to determine its valuation. Depending on valuation, some tax-related activities, such as the sale, purchase, or stock donation in a firm, can be taxed.
Why do you need to value your business?
Business valuation is required for many reasons. Here’s a short list of why you might need to value your business–
- You want to sell it
- You want to seek investors
- You’re issuing stock
- Need a loan from the bank
- You need to understand the growth potential
Seeking investors or buyers for the business is the most common reason for business valuation. Once you know your business’s worth, you can confidently negotiate the selling price or investment amount.
Factors that affect business viability when looking for a sale
When it comes to valuation for sale of a business, three fundamental factors influence the company value, as listed below-
- Circumstances of sale – The motivation behind a company’s sale can impact its worth and sale price. The value will probably decrease if the deal is forced to happen in a situation, such as the sudden death of the owner, as opposed to protracted negotiations in an acquisition offer with an informed owner backed with thorough valuation.
- Tangible and intangible assets – Businesses can have tangible assets that can be measured in terms of resale value. Additionally, they can have intangible assets, the value of which cannot be found directly. These intangible assets can be reputation, large customer base, intellectual property, and growth potential. Both assets can affect the valuation for sale; however, the latter is more difficult to value.
- Operations years – The track record, working capital, and repeat clients are all the better for a firm that has been in operation for longer. Be cautious about such pubs and cafés, that have only been in business for one to two years before becoming up for sale. It’s possible that such businesses are enjoying a moment of popularity, but the market could be set to swing against them.
How does the industry rule of thumb work when valuing a business to sell?
In a market economy, the equilibrium price is established by the forces of supply and demand. Our research has shown that, over time, rule-of-thumb valuations are as close as possible to the true value of a company. When applied correctly, rules of thumb can give a reasonably accurate estimate of a company’s market value. Depending on the sector a business belongs to, standard rules of thumb contribute to determining the value of a business. Therefore, valuation for sale must consider such industry rules of thumb. However, common methods for roughly estimating a company’s worth include the following two rules of thumb:
- Using a multiple on the company’s discretionary profits.
- By taking the company’s annual gross sales and multiplying it by a certain percentage.
Most businesses today originate from a wide range of industries. To elaborate, let’s check out this top-grossing business categories list
- Software (system and application) (system and application)
- Computer Accessories
- Pharmaceuticals and Drugs
- Gas and Oil
- Home goods
- Computer Services
- Healthcare Assistance Services
- The Semiconductor Sector
Valuation analysts utilize a variety of methods and formulas to determine a company’s worth in these sectors. The methods used for calculations will be elaborated below.
How to prepare your business for a sale?
Even if you do not plan to sell your business, it’s a good idea to understand the steps required to prepare for a business sale.
- Determine SDE by preparing financial statements – Assemble the last three years’ financial documents, including balance sheets, cash flow statements, and income statements. Collaborate with a Professional to convert your financial information into a seller’s discretionary earnings (SDE) statement. SDE considers one-time expenditures and luxuries to more properly depict the worth of your company. SDE contains costs that aren’t necessary to operate the firm. Therefore it offers you a more accurate picture of the actual earnings of your company. Consider utilizing a projection model if the company hasn’t been operating for three years.
- Research your industry – When selling a business, owners must be familiar with their industry. The SDE multiple of a company fluctuates depending on several variables, including the industry. The sellers must learn about comparable firms or comps if there is data available. Sellers can determine an accurate valuation for sale that considers both the company’s assets and the present market by having a thorough awareness of the trends in your sector.
- Calculate the value of assets in business – Estimate the value of tangible and intangible assets of the company with the help of professional business valuators, such as Eqvista. You can better understand the company’s current worth via asset valuation; so you can anticipate your company’s earning potential regarding the available resources.
- Use the right multiple and methods to value business- Price multiples represent anticipated earnings and provide purchasers a tool to calculate their expected return on investment. They offer a rapid broad estimate of the selling price of the company. This step often comes after asset valuation. The multiple is determined by considering many factors, such as the industry and geography of the business. The multiples come together in an equation to yield a reasonable estimate of the company’s selling price.
- Use comparable or comps ‘for sale’ and sold business- A standard method for obtaining an accurate representation selling price of a business is through getting data on sales of similar firms or comparable companies (comps.) You can get a more precise selling price by finding examples of comparable companies that have sold nearby. You could focus your research by sector and region and narrow the search by gross revenue and cash flow.
- Improve the value of the business and get experts’ help- Employing a qualified business appraiser gives you access to their experience and the perspective you could lack when determining a fair evaluation of the company. The owner can make the projected worth better by using the insights from an expert. However, the sooner the owner seeks expert assistance and starts making efforts to raise the sale price of the company, the better. Keep in mind that purchasers are drawn to companies with the best chance of making money in the future. The firm will gain value if evidence of several years of profit growth is shown.
How to value a business for sale?
Valuation for sale allows business owners to put a price on the sale and negotiate with a buyer willing to pay the price. Companies can utilize several business valuation methods to reach this value.
Choose the right business valuation method
Remember that there is no single, widely accepted valuation method. It is possible to arrive at the final figure by utilizing multiple approaches. You and the buyer or investor may also need to come to an agreement on the valuation approach.
To determine which strategy is most suitable for your company, seek the advice of an expert. The following are some of the most often used business valuation methods to attain the valuation for sale:
- Asset approach – This valuation method adds the value of all the assets minus the liabilities. If you are an owner of a dependable, asset-rich company, use an asset valuation method. The investments mentioned in the accounts serve as the foundation for the value of business assets. This is the company’s net book value (NBV). The NBV statistics for the critical assets are then adjusted to reflect the current state of the business economy.
- Income approach – Income business valuation is based on anticipated cash flow or profits. It’s excellent for enterprises with significant growth potential. This approach uses two methods- capitalization of earnings and discounted cash flow (DCF). The capitalization of earnings approach assesses a business’s profitability using cash flow, ROI, and projected value. The capitalization technique implies that single-period computations will continue. Established companies with sustained profitability utilize this method. DCF indicates future company viability with fluctuations. The business’s cash-flow estimate is altered (or discounted) according to purchase risk, allowing for additional financial volatility. This strategy works well for young, high-growth enterprises that aren’t yet profitable.
- Market Approach – The market approach to business valuation bases a company’s worth on the buys and sells of similar businesses in the same sector. With reference to your local market, this method will assist you particularly decide on a suitable selling or purchasing price. To get the typical trade multiples, discover businesses in your industry with comparable finances and business strategies. Return on capital, PE ratio, EBITDA, price to book value, and return on assets are some of the multiples that are typically utilized in this strategy.
- Price-to-earnings ratio – The price-earnings ratio (P/E ratio) is calculated by dividing the market value of a company by its profits after taxes. Selecting a suitable P/E ratio is complex, and you’ll need to defend your decision to a prospective buyer. Working with a professional is required to employ “standard” industry average P/E ratios since specific sectors have them. Businesses may use the following equation to determine a company’s value- Business Value = Earnings after tax × P/E ratio.
- Entry cost valuation – An entry cost valuation considers the price of creating a similar business from scratch. Calculate the cost valuation of the company by considering the cost of acquiring or financing its assets, producing goods or services, hiring and training staff, and establishing a clientele.
Tips to obtain the right valuation for your business
Now that you know how valuation for sale works for a business, here’s a list of tips to follow to get accurate valuation:
- Do not consider capital assets – Understand that asset and business value are two different things. Asset value gives the worth of the assets owned by your business and the business’s funds tied up in the form of assets. A buyer doesn’t care how much they can gain from your assets. They want to know how much money they can make from it.
- Look for profitability – Buyers aren’t concerned with your revenues; they only need to know your basic operating wage to understand the business’ future profitability. Your net earnings are multiplied using multiples appropriate for your industry. You must examine previous financial data for your business, predicted growth, and the development of your rivals to ascertain the amount of growth or profit loss you may anticipate over your applicable multiple.
- Calculate the correct value – You must have a lengthy calculation to calculate the correct value of the business. First, get a net income by subtracting expenses from gross profit. Then, multiply the net income with an appropriate multiple based on the industry. Depending on your market, you can calculate future profits and determine your company’s growth potential by comparing it to the present growth rate against the market. Finally, add all the growth projection values to get the business’s correct value.
- Consider essential factors in market valuation – Recognize that your company is worth what the market estimates. Your assessment is a guide to negotiations. You’ve produced a value that you can show to buyers and investors. However, this does not imply that your value to your company is genuinely justified. It is not an acceptable value if you cannot get the total valuation price during an acquisition. The market will always determine the entire worth of your company.
- Accept the will of the market – If the market doesn’t support your estimates, you may need to make some adjustments. You may be unable to afford to be obstinate with your figures if you need funding to survive or must sell immediately. Even if your brand is worth substantially more, factors like timing and the higher necessity for your business in the market continue to be important. Leverage is a constant in business. It is important to accept that you seldom receive what you deserve; instead, you usually get what you can bargain.
Get an accurate business valuation report for your business with Eqvista!
Are you looking for a business valuation for the sale of your business? Eqvista can help! To help firms function more efficiently, a group of accountants, lawyers, valuation experts, and company owners operate around the clock at Eqvista. With the help of a business valuation offered by our highly qualified valuation experts, you can evaluate the worth of your company, assets, revenue, and other criteria. We can assist you in negotiating the best deal for your buyers. Contact us to learn more about our valuation services.