The Basics of Business Valuation
Updated: Oct 10, 2022
How is my business valued? How do I figure out future transition plans? Can I protect my business and help my employees? These are just a handful of the questions that are constantly thought about by business owners. This past week, I had the pleasure of interviewing Jeffrey Brewster, CFA, CVA on the specifics of business valuation. The whole interview can be found here; however, there are a few highlights we can cover here today.
The main question is how exactly are businesses valued? There are many answers to that question but the majority revolve around a multiple of cash flows. The exact answer is that a business (not dissimilar to stocks) are valued by taking a present value calculation of expected future cash flows. You might be leaving money on the table if you try to boil it down to a simple multiple of future cash flows.
What are some ways that you can consider preparing for a future business sale? There are many ways, but a lot of them revolve around preparing for the due diligence process that comes when a potential buyer starts getting deep in your operations. Some ways that you can be ready for that would be: 1) having well constructed financials books and systems that follow commonly accepted principals, 2) have your books audited by a third party to verify their validity, and 3) consider diversifying your customer base and not having a concentration of clients or a concentration in an industry.
Another thing that you can start and maintain at any stage of your business is to have a business plan and actively engage with it to help prepare and show growth and purpose over time. There are many key elements of a business plan but some of they key areas can be integrating a marketing plan and strategic elements as well as a financial plan that includes financial proformas and projections of numbers. One area that is frequently implemented into business plans are the usage of a SWOT. That is a review of strengths, weaknesses, opportunities, and threats. An example SWOT that focuses on maximizing business value could be depicted in the example below.
What are some of the other key areas to think about when it comes to business valuation? One primary consideration is to consider the kind of business transition you may you may want to have. There is a difference between positioning your company to be acquired by a private equity group, going through funding rounds with hopes of going public, and a legacy minded owner that wants to take care of their employees and possibly ride out their retirement as an emeritus chairperson.
Lastly, how early is too early to start thinking of these things? Really, at any time it can be a good idea to seek guidance. A company that is pre-revenue but has a phenomenal idea may be able to get an investor based on just their business plan. While another business that has been around for 10 years and has very low profit margins but supports the owners lifestyle alone, may not be in any rush to talk transitions. The best plan is to have advisors in your world that can walk with you and help you to make the best educated decisions possible.
The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material, and does not constitute a recommendation. Any opinions are those of the author, and not necessarily those of Raymond James. Raymond James is not affiliated with and does not endorse the services of Jeffrey Brewster. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.