Most business appraisers will agree that business
valuation is a unique combination of art and
science. Because there is not a universal
formula that can generate the exact value of a
company, deriving the accurate worth of any
business requires the consideration of many
factors.
Earnings
Ultimately, the value of your business is
determined by what someone would pay for it in the marketplace. The buyer is looking to
purchase a future income stream that will provide a desired return on his or her
investment, which will justify the purchase price. As a result, most appraisers base their
valuations upon multiples of earnings in which the historical and future earning patterns of an
operating business become the biggest factor in
determining value.
Risk Factors
If all factors were equal, earnings would be the
sole determinant of a company's worth. However, every company has unique risks
associated with its operation, and appraisers must weigh the company's future opportunities
against the perceived business and economic risks. Elements of the business that increase
risk will decrease value, and conversely,
elements that decrease risk will increase value.
Some risk factors that influence valuations are
as follows:
Diversification
By diversifying the company's customers,
suppliers, product lines and employee talent, a
company reduces its risk in case of market
turbulence.
Infrastructure
A solid infrastructure of people within the
company helps decrease a buyer’s risk, and
therefore increases the business' value.
Talented managers, trained employees and
established operational systems help the
company run like a well-oiled machine, meaning
the company is more able to transfer seamlessly
to a new owner.
Timing
The value and risk of a business depends on
many time factors, both internal and external.
Internally, a company has less risk if it displays
a positive trend of historical financial performance. A healthy future earnings
projection also decreases the company's risk.
External factors, such as industry stability,
market conditions and economic outlooks, all
shape the company's future performance
expectations.
Assets
In an asset intensive business, the conditions
and efficiency of equipment affect the value of
the business. Well-maintained equipment
means buyers will not need to invest significant
funds into upkeep and repairs. Likewise, the
value of intellectual property or proprietary
content will also increase a company's value.
Appearances
The way a company looks, both physically and
on paper, affect the perception of value and risk
to a buyer. The organization and efficiency of
the working environment reflects upon the
company and its overall management. Clean,
organized financial statements will increase the
confidence the buyer has in the company’s
actual performance.
Finance-ability
Most buyers will require a lender to finance a
portion of the transaction. Whether through atraditional bank loan, a SBA loan, a private
equity fund or from friends and family members,
the amount financed will determine the amount
the buyer can offer. It is important to remember
that in all transactions, bankers will be
scrutinizing the company's financial statements.
Clearly document all transactions, outline any reconciliations and owner perks and write-off old
inventory and receivables.
Terms and Structure
Tax implications are a major factor in valuing a
business because it greatly affects the cash flow
of a company during the vital first years.
Structuring the sale as an asset or a stock sale
has conflicting benefits and consequences for the
buyer and seller. In addition, the amount the
owner is willing to have at stake after the
transaction also reduces the buyer's uncertainty.
A transaction with owner financing or earn-out
will have a higher price than an all cashtransaction,
but the owner must be willing to
shoulder the risk associated with these types of
structures.
Conclusions
There are many other factors appraisers
consider when valuing a business. With so many
variables to consider, the best way to ensure an
accurate value is to meet with an accredited
business appraiser.
