What Is My Business Worth? Practical tips for CFOs
That’s one I get a lot… “What is the business worth?”
“Give me a rough idea - back of the envelope.”
And, as an old mentor of mine known as ‘Dr. Value’ would say: “It Depends.”
Most Chief Financial Officers don’t wake up one morning and think: “I wonder what the business is really worth?”
Ok, some do. But they usually lose that enthusiasm at the notion they need to spend a few bucks to get the answer.
The reality is a valuation is typically performed because someone else will tell you that you need to have a valuation performed. It’s usually in order for you to complete some other task - the real objective - if you will.
Here are some business objectives that will trigger the need for a business valuation:
Objective #1: You’re trying to incentivize key employees with stock-based compensation.
- Your accountant advises that to put this compensation plan in place you must have something called a 409A valuation done…and you thought that they were talking about cleaning your kitchen.
Objective #2: You’re trying to gift shares of the business to the owner’s children or grandchildren.
- Your attorney advises you need a valuation to satisfy the requirements of the IRS.
Objective #3: You’re trying to raise capital either through private equity or a public offering.
- You’re told by both your accountant and your attorney that you need to have those stock options valued. (No, they’re not ganging up on you!)
Objective #4: One or more of the owners would like to sell their shares
- Book value doesn’t work, the Buy/Sell agreement you have in place has expired and nobody wants to feel cheated. You need a valuation.
How to Value the Business
There are several methods used to value a business, but at a high level, there are two key fundamental ways to think about the value of your business:
- The value of your business is equal to the present value of the future monetary benefits it can deliver. (Income-Based Approach)
- The value of your business is equal to what someone else is willing to pay for it. (Market-Based Approach)
Naturally, the only way to know for certain what someone is willing to pay for the business is to put it on the market, but knowing the value similar businesses changed hands at will get you in the ballpark.
If you’re not familiar with these valuation techniques and you’d like to learn a little more, you will enjoy learning more about these methods from this article, In The Shark Tank It’s All About Valuation.
Why It ‘Depends’
The value of your business (or business interest) depends on what exactly needs to be valued, why it needs to be valued, when it needs to be valued and for whom it needs to be valued.
A few things to consider:
1. Is there debt on the balance sheet? If the answer is ‘yes,’ the value of your business depends on how much. As an everyday example, if your house could be sold for $300,000 today but you have a mortgage (debt) of $200,000, your equity interest is only worth $100,000. The same is true for the business.
2. Is your valuation as of a recent date or do you need to go back in time to say, the date of someone’s passing for an estate matter? Markets and valuations change over time.
3. If your needs pertain to a minority ownership interest in the business, understand that it will generally be worth less than a controlling interest in the business.
4. The value of the minority interest also depends on what other classes of equity have preference ahead of it.
5. Furthermore, if that ownership interest is illiquid, understand that it will be worth less than if it were traded on an exchange or otherwise lacked the restrictions on liquidity.
6. Using the “back of the envelope” to value a business with a rule of thumb is not the solution. There is no Silver Bullet of Business Valuation.
** Bonus Tip For Chief Financial Officers **
Have you been running the business with a strategic goal of trying to minimize the tax liability of the owners? If so, the tax elections you made will give the tax return a poor picture of the company’s profitability. Make certain you have proper financial statements prepared under GAAP or IFRS. Reviewed or Audited statements may be required.
So if you do wake up one morning wondering “what is my business worth?,” remember that “It Depends.”
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