So, you've decided that it's time to exit your business and you are looking to sell, but how do you determine a fair selling price? Business owners and potential buyers usually have two very different figures in mind, which is why it is so important that a business is accurately valued. A business valuation ensures that both parties have a good understanding of what the business is really worth, helping to speed up negotiations and simplify the sales process.
If you are planning to sell your business, here is our quick guide to business valuations. Continue reading to find out which valuation method will help you maximise the value of your business.
The benefits of a business valuation
Pricing a business can be difficult. On one hand, no business owner wants to settle for anything less than what they believe their business is worth, but on the other, nothing deters potential buyers more than an unrealistic asking price. A business valuation can help you determine a price point that accurately reflects the current worth or, in some cases, the future potential of your business.
In addition, a business valuation may unearth weak points that can be improved to maximise the overall value of the business. This can include settling outstanding debts or de-risking the business to put it in a better financial position before it goes to market.
What affects the value of your business?
Determining the value of your business requires a comprehensive assessment of basically your entire business, in addition to external market and economic factors. A valuer will usually take into account a broad range of different variables, including:
- Current profitability and future reliability: How profitable is your business, and how reliable are those profits in the future?
- Current assets and working capital: What is the value of your current business assets and the state of your operational capital?
- Reliance on the owner and key personnel: How reliant is the business on your involvement or that of key personnel?
- Growth potential: Does your business have a history of sustainable growth that points to a strong potential for growth in the future?
- Industry considerations: How large and profitable is your current market, and what is its potential for growth?
- Economic considerations: What is the current condition of both your industry and the economy as a whole?
- Perceived risk: What risks, including legal, political, or financial, may affect intrust from potential buyers?
Common Business Valuation Methods
The three most common business valuation methods are an asset-based approach, an income-based approach and a market-based approach. Each method highlights different aspects of your business to paint the best possible picture for potential buyers. Depending on variables, such as the financial position of your business, the assets it holds, and the condition of the market, a valuer will recommend an approach that maximises the value of your business.
Asset-based approach
An asset-based approach values a business based solely on its net asset value. This is the total value of all business assets, including equipment, cars, real estate and intellectual property, minus its liabilities, such as wages owed, bank debt and other outstanding expenses. If your business holds large investments or real estate, this method can help you emphasise these high-value assets for a better overall valuation.
However, an asset-based approach does have limitations. Unlike other methods, the asset-based approach doesn't take into account the future earning potential of your business. But, if your main objective is liquidation, it can help you quickly and easily determine the total value of your assets if they were to be sold or otherwise disposed of today, item by item.
Income-based approach
An income-based approach uses current and historical performance to estimate future income, which can be calculated in two different ways:
The Discounted Cash Flow (DCF) method takes a snapshot of your cash flow over a specific period of time (usually five years) and uses that to forecast future earnings. If your business is in the early stages and your earnings are less predictable or if your cash flow fluctuates a lot due to the nature of your industry, DCF can give you a more accurate valuation that averages the highs and lows of your business.
The Capitalisation of Maintained Earnings method uses the assumption that your profits, finances and growth will remain reasonably steady from year to year to predict future value. If your business is well-established with stable earnings or if you operate in a mature market, you can very accurately estimate expected future earnings by using this method.
Market-based approach
A market-based approach uses recent transactions involving comparable businesses to determine 'fair market value'. This valuation method relies heavily on external market forces, drawing from publically available data on similar transactions. If your business operates within a highly-standardised industry with limited unique assets, a market-based approach can give you a very straightforward valuation with fewer assumptions than an asset or income-based approach.
Not without its own limitations, the market-based approach relies on the transparency and availability of comparable market data. If you are in a small niche market or one that often fluctuates, it can be difficult to obtain relevant financial information and create an accurate business valuation.
Consider professional advice
While you can self-assess your business, an experienced professional valuer can help you maximise the value of your business based on your specific situation or work with you to implement a plan to achieve your desired value. In either case, having their knowledge and expertise in your corner can be a huge advantage during what is such a significant transaction.
Related: 5 Mistakes Business Owners Make When Selling Their Business
Azure Group's Corporate Advisory Team has considerable experience in undertaking business valuations across a range of different structures, including companies, trusts, partnerships and unincorporated joint ventures. In addition to valuations, our advisors can assist you in each stage of your transaction, from managing complex negotiations to developing a comprehensive business succession strategy. If you are looking to prepare your business for sale, contact the team at Azure Group today.
Have you noticed our #FridayExpertTips? Here's one that relates to Corporate Advisory.
“As a business owner, there will come a time when you start thinking about moving on and exiting from your business. Regardless of your reasons and the strategy you choose, you will undoubtedly improve your outcome if you seek professional advice along the way. Succession planning and timing your exit is essential in gaining the best outcome for your circumstance."
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