A quick Google search provided 402,000,000 results when I searched that question. Needless to say, there are lots of opinions on this topic. There are many factors that affect business value and I have listed some of these important items below.
Not all business valuations are equal. It depends on the purpose and although there are many, here are three major value types that are common.
• Liquidation Value – Typically used for an unprofitable company that is selling off equipment and other assets.
• Fair Market Value – Most often, Fair Market Value is assigned to a business or its assets for tax purposes. IRS Ruling 59-60 governs FMV and determines a business’s worth in order to assess personal and property taxes on it. However, Fair Market Value can also be used to determine a business’s value if business partners or spouses who own equity in a business are separating or divorcing and for things like internal Buy/Sell Agreements, ESOPs and Estate & Gift Tax planning.
• Strategic Value – This is the one that really matters if you are planning to exit your business and sell to an external acquirer. This considers businesses that have sold within your industry and multiples and prices paid. Strategic buyers will often place a “premium” over and above Fair Market Value.
Strategic buyers almost always pay the highest price because they may have reasons to make the acquisition beyond cash flow and profitability.
Most acquirers want an upward trajectory when looking at revenue and net earnings. Equally as important are Gross Margins. Buyers are concerned when Gross Margins are not at above-industry norms. For example, in manufacturing, a Gross Margin of 35% or more is typically what is expected. When all of these are in alignment, the business will sell at a higher multiple.
Recasting is the accepted accounting principle of removing or adjusting items on your financial statements that are unrelated to the ongoing business. You have probably worked hard over the years with your accountants to under-report your earnings for tax purposes. This is perfectly legal and acceptable. But it understates the true value of your company. It is critical when you are calculating your business value range that you understand the recasting methodology and use it effectively to calculate net earnings and EBITDA, before applying any multiples to determine value. To put it simply, your tax returns and even financial statements for that matter, do not reflect the true profitability of your company.
What is this and why is it important? According to Investopedia, EBITDA is Earnings Before Interest, Taxes, Depreciation, and Amortization, and is a measure of a company’s overall financial performance used as an alternative to net income in some circumstances. For the purposed of establishing a business valuation, it is a common practice to normalize EBITDA. You would have seen this term as “Adjusted EBITDA.” These can be positive or negative adjustments, and the reasons include, but are not limited to, non-recurring revenues and expenses, non- business/personal-related expenses, and facility rent and/or owner compensation above or below fair market value.
One common method for buyers to determine a starting point for a business value is to apply a multiplying factor to adjusted EBITDA. Most businesses trade at 4-6x EBITDA, but there are some that are in the 6- 8x or even 10x range or more. This is determined by industry, company size and many other important factors listed below. An M&A firm with experience will use various resources to determine multiples for a particular business including closed transactions and prices paid. This, along with other factors, can generally provide a fairly accurate estimate of value or value range.
Here are just a few other important factors that can greatly influence value:
• The company’s dependence on the owner
• Customer concentration
• Length and stability of customer relationships
• Barriers to entry
• Patents and unique technologies
• CapEx (Capital Expenditure) requirements
• Industry certifications
• Quality of management team
Touchstone’s Estimate of Value (EOV) is a good starting point for business owners looking to get a range of what their business will most likely bring. But in the end, the true value is what someone will pay for your business, and with strategic buyers that amount can be significantly more than what a financial buyer would pay. Lastly, it is critical to understand the strategy in obtaining the highest possible price for a business. That starts with not assigning a price tag, instead letting a buyer determine price while putting him in competition with other acquirers. Competition will almost always result in a higher price paid.