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Business valuation: understanding your company’s value
By ATB Financial 14 December 2020 8 min read
As a business owner, you know how much your business is worth—almost your everything. But worth is different than market value when looking for equity to fund growth, bringing in a partner, planning a tax strategy or selling.
That’s where a business valuation comes in. Business valuation creates an objective, independent and realistic appraisal of your enterprise. Valuation is a complex process where a trained business valuator will look at many factors to determine the value of your business, including financial results, market trends, the competition and overall business health.
The outsider’s view is critical when there are two dramatically different expectations on the table.
“I think sellers have a different view than buyers—for sellers, the business is heart and soul,” says Maria Gafiuk, ATB entrepreneur strategist. “The buyer is looking for the value—what am I buying, what are the assets that I’m buying, the goodwill and how do I maintain or grow that net profit.”
A business valuation can also identify how to make your enterprise more attractive, from a value perspective, and highlight areas of opportunity to drive growth. It is truly a unique process for each business, part science and part art.
Business valuation: getting started
“There are two types of things we call value,” says Fernando Alves, ATB entrepreneur strategist. “Notional value also known as fair market value is used in situations where value must be determined without exposing the business for sale on the open market. It can be used for court, tax planning and financing for example. Then there is the price, when you bring that notional value to the market, meaning you sell or buy a business for a certain value.”
As a business owner, you know assets generally fall under two categories—intangible and tangible. Both influence the overall success of an enterprise and its valuation.
Outside of tangible assets are elements that reveal more about the company’s position and future direction. A comprehensive valuation will look at key indicators for buyers such as brand recognition, customer lists, workforce size, patents, valuable IP and business processes. Goodwill also makes up an intangible asset a buyer will be analyzing during due diligence procedures.
But what you need to show is that the goodwill is attached to the enterprise, rather than your charismatic personality. “Because a buyer or partner will want to know the business will continue succeeding if you’re not in the picture,” notes Gafiuk.
Having long-term contracts in place is another big value determinant. They show guaranteed pricing for inputs that stems from the business’s processes, as opposed to the owner’s relationship with the supplier.
What you have as tangible assets, like machinery, land and buildings, plays a part in showing that investment is associated with the business and brings value to the company, says Alves.
The core element of a valuation is based on future expectations of earnings or cash flow the buyer can estimate to earn from their purchase.
One of the first things people often ask for when deciding to get a valuation is what multiple to apply to the earnings or cash flow of their enterprise, Alves notes.
A nuance of valuing of a business is leveraging a cost of capital model. This process combines the interest rate on debt and the expected return on equity.
Valuations vary in methodology and detail, depending on what you are using it for and the size of your business. Gafiuk uses three methods and weighs them to obtain a final value.
The most common is the market valuation method, which looks at trends over three to five years, and normalizes the income statements during that period. The multiples method looks at what other similar companies sold for and at the discretionary earnings of the business. It also rates a variety of factors that influence business performance, like management, location, ability to raise finances, processes, policies and products.
They are often expressed in a range, and where a business fits in the range is a function of the risk the buyer is assuming. The number one thing a business leader can do to lower that risk is ensure the business is smoothly transferable to a new buyer and will function just as effectively without you running the show.
Keys to making your business more valuable
A strong team—Strong management is a strong selling point as it will help keep the business running after the original owner leaves, giving the buyer confidence they have the support to be successful, Gafiuk says.
Product diversification—A number of well-defined products in the marketplace increases value and decreases risk since if there’s an issue with one product, it won’t affect the entire business.
Back-up suppliers—The pandemic has emphasized the impact of supply chain disruption on business, from small to large. Having alternative sources already in place is beneficial.
Process and policies—Formally documenting business process and policy can increase the business value by enabling work continuity, smoother transition and even cross-training opportunities for staff.
Partners—Partnering with other companies makes you stronger and increases marketability.
Numbers—A service-oriented business or one that is not capital intense can improve their margins to increase value, says Alves. “If they can reduce operating costs, that usually translates into more discretionary earnings, that will be multiplied by a specific rate to get its valuation.” If the business is capital intensive, like a manufacturer, you might want to increase your revenue and invest in more capital assets, he adds. “That would generate more discretionary cash flow that would translate into a higher valuation.”
Choosing the Right Chartered Business Valuator
It’s important to choose the right professional for your specific business valuation. The size and complexity of your enterprise and circumstance play a big role here.
If your enterprise is large and complex, partner with a chartered business valuator who will provide reports that will stand up in court if disagreements over value arise. For example, say a government put in a road and it affected your business. A certified business valuation would be relevant to make a claim against that impact. Using a certified valuator can also be useful in the case of a divorce, estate dispute or sale of a subsidiary.
If you lead a small-to-medium-sized business, you should consult with your accountant to develop a roadmap to normalized EBITDA. Also, network within the market for what comparable businesses are achieving. A key resource to consider reviewing is the Business Reference Guide: The essential guide to pricing businesses and franchises which is commonly used by business brokers to get industry rule-of-thumb valuation approaches.
As with most strategies, planning ahead can take your farther. It can also be highly dependent on your unique situation.
“I would say to have a business valuation done four to five years in advance of your planned exit, not only to have an idea of what its value is now and if it’s going to be enough to retire on, but also to have the time to make changes in the business if it is not, and show in the financials that the changes are successful and feasible,” says Alves.
If you just want to have an idea of where you are in the marketplace, you can have a simple valuation, then do another after changes, and then a more in-depth one when you are exploring an exit more seriously. If an external factor, like a divorce, death or market drop, is driving the valuation, you might require just one valuation.
Positioning your business for purchase financing
Like other financial institutions, ATB looks at the strengths of the borrower, the business plan, the financials and the value of the assets, when evaluating a business. With large companies and corporations, more onus is put on the business financials and less on the strength of the owner.
For companies that are small and where we would not be able to finance the goodwill portion for higher risk companies, lenders will often seek out strategic partners like the Business Development Bank of Canada (BDC), though BDC’s interest rates will usually be higher on approved loans.
Another financing option for someone looking to acquire your business, is an outside investor, who generally will look at the return on investment.
Don’t forget the tax man
There are always tax implications in any deal and if that tax is high, it will impact a valuation. Work with your tax advisor to build a strategy to minimize that burden before moving ahead. For example, if you sell shares of a company you could be taxed less than if you sell assets. Or if you hold real estate separate from property, that will also affect taxation.
Words of caution
The impact of the coronavirus pandemic on the economy has elevated uncertainty and market risk levels. Whether buying or selling, acquiring financing will be more difficult as financial institutions’ appetite for risk is low, and most have made rules more stringent.
On the buyer side, there will be a lot of consolidation and increasing competition for prime targets. Also worth noting is that a 2017 survey found nearly half of over-50 business owners in Canada are considering selling in the near future, which may further ramp up rivalry for attractive companies.
On the seller side, your business value could have dropped, so you might hold back on selling unless you see a lot of calls in your industry.
Find out more about selling your business successfully with ATB’s Business Transition Guide. Want to talk some more? For tailored advice around business transition planning reach out to our Business Transition team at firstname.lastname@example.org