The Importance of Business Valuation
NiteHawk is committed to helping our service partners thrive, and recently we’ve been reminded of the importance to all of our partners of business valuations. A valuation analysis is a time-consuming, expensive process, but the benefits to your business both today and down the road are difficult to understate. Here is a brief explanation of what a valuation entails and how it can help you strengthen your business.
IN THIS ISSUE:
Business Valuation - Understanding why business valuation is important
Owner Spotlight - Scott Gettier in Virginia
Types of Business Valuation Methods - Tips on how to increase the value of your company
Conduction a Valuation - The basic process of conducting a valuation of your company
Improve Your Business Value - Strategies to identify the exact worth of your business
Most owners will choose to hire a business broker, someone with advanced training in business economics and experienced in analyzing companies like yours. You’ll learn where you stand relative to others in your market or region through two main analytical tools: asset valuation and earnings valuation. Asset valuations consider each component part of your operation contributing to cash flow, including equipment, land, maintenance tools, furniture, brand images and other intellectual property, and employees. These totals establish the “floor” or the company’s minimum worth.
The “ceiling,” or maximum value, assesses both current and future earnings. Estimations consider future market developments, new competitors, and possible scaling up of your operation to meet increased demand while maintaining profitability.
Why It Matters
The true goal of a business valuation is not to know what your business is worth, but to generate metrics by which you can create goals for improvement. You are searching out weaknesses, not strengths.
Owners tend to know what they need to fix, and a valuation is the excuse to finally do it. In the sweeper industry, for example, all drivers should go through a certification program, but some of our clients send out new drivers after just a few days of shadowing another employee. Increasing your company’s value means decreasing all liabilities and completing the tough improvement projects you’ve been avoiding.
Where It Will Take You
A valuation analysis helps you translate each detail of your operation into hard data. Your ultimate goal as a business owner should be to be able to sit on a beach somewhere, look at a single piece of paper, and know exactly where your business stands each day. The valuation process will help you generate that data, fix what needs to be fixed, and leave more time to have fun with your business, explore creative projects, and live your life outside of work.
Scott Gettier is the President and Founder of Virginia’s Gettier Commercial Inc., a booming operation covering commercial property services from sweeping to asphalt and concrete. Up against ever-growing demand, Scott and his 150 employees have built a reputation for reliability. “A property manager needs to know when they hang up the phone, the work is going to be taken care of. When we say we’re going to do something, we do it.”
In the early days of Gettier, Scott was running a one man show. “It was just me,” he remembers, “burning the candle at both ends. I’d sweep at night and sell during the day. I’d cut grass, rake leaves, anything to pay the bills.” With 26 years of hindsight, Scott sees those early days as a time of incredible growth, and also learning some lessons the hard way. “I was bullheaded and thought I could do everything myself. But now I understand how much better the company operates with the right people in place. In every company, it’s all those people behind the scenes that make the difference. Good people are the foundation.”
Scott credits his solid support back at the office for enabling him to spend more time with his family and visit his kids in college. You can also find him on his boat in the Bahamas or the Florida Keys, enjoying all types of fishing. He even competes in various billfish tournaments up and down the east coast. “It’s my favorite pastime turned into something competitive. It’s a lot of fun.”
Scott’s advice to other aspiring business owners: be prepared for the emotional roller coaster ride. “You’ll have days with extreme highs—landing good contracts, completing big projects. And then there will be days with extreme lows – accidents and wondering if you’re going to cover payroll for the week. You’ll wonder if this is really for you.”
Scott has loved his years on the small business roller coaster, but he’s looking forward to calmer times. “Northern Virginia is a great place for work, but it’s too fast paced. I want to be somewhere where I can fish and live on the water, maybe South Carolina or Florida. Water has a calming effect, I just want to be somewhere where I can relax.”
This is our second article in a four-part series on business valuation. This topic may seem drier than burnt toast, but stay with us. Understanding your company’s true economic value is crucial for success!
If you ask a broker, there are a BUNCH of different valuation methods with lots of technical differences. Here we’re just going to explain three different approaches, so you can start thinking about which would most benefit your company. Knowing these concepts will also help you be more effective in discussions with business brokers, should you choose to hire one, and also with potential buyers.
The Asset Approach
Imagine breaking down your company into all its smaller parts—each piece of equipment, each piece of property, your stock—and pricing each one on the market. What have similar assets sold for recently? What might they be worth a year from now, based on current trends? Another way of framing these questions is: how much cash flow does this one asset generate? Total up all of those amounts, and you have an asset-based business valuation.
The trick here is to be thorough and detailed. Every little thing, even office furniture, has some worth. Think also about non-physical assets, such as your brand. Remember to include the worth of any intellectual property you own. And of course, don’t forget your people. Most of the worth of an organization will be in its people.
It’s very important to understand how much your assets are worth, but focusing on them too much in a valuation analysis can make you miss your company’s earning potential. For this reason, an asset valuation should often be paired with an earning-based evaluation (explained in the next section). Or, you would do only an asset evaluation for a company that has no earning potential (a.k.a. a failed business). Finally, asset valuations are helpful for liquidating all or part of an operation.
Think of the Asset Approach as establishing the “floor” of your valuation analysis. What is the minimum worth of the company if you only factor in its component parts? Whether or not you have plans to sell, it is always good to have this information up to date. Knowing the worth of your company’s components will help you make informed decisions about your own sales and purchases.
The Earnings Multiplier Method
Another valuation technique is the Earnings Multiplier Method, sometimes called the “Time Revenue Approach.” The questions you’re asking here are these: what would my company be worth a year from now? What about in two years? This method emphasizes overall cash flow more than component assets, and it bases the price of your company on some multiple of your company’s earning potential. For example, if your company is growing very slowly, or you’ve faced many barriers to expanding, you would multiply your cash flow by a number close to 1. If there is a lot of potential for future growth in your industry, the multiplier could be higher?
If the Asset Approach determines the “floor” of your business’s worth, the Earning’s Multiplier Method gives you a “ceiling,” or the maximum that someone might pay given projected cash flows? Knowing these boundaries will help you be more effective in negotiations and reach a price that is satisfactory for you and your buyer.
The Market Approach
The Market Approach focuses more on the economic landscape in which you do business. This will be especially important to buyers who do not have a lot of experience in your market. How much competition is there in your field? When new competitors come up, what keeps your company ahead of the pack? Is there a lot of potential for this market to expand, or is it saturated?
If possible, it is helpful to look at data from other companies and see what they have been bought and sold for. This is one of the advantages of using a business broker, because their experience will come with knowledge of other companies.
Hopefully you now have a sense of the general methods used in business valuation analyses. In our next article, we’ll walk you through the basic steps of beginning a valuation of your company. You won’t want to miss it!
Our previous two articles in this series focused on the importance of business valuation and methods for doing one. Regardless of the approach you take, this article will provide some key steps you need to follow to conduct an accurate valuation of your business.
1. Document profits and positive cash flow
Hopefully your business already keeps careful records of profits. If not, start today! Make sure your data is organized and readable for someone unfamiliar with the company. Ideally, you will have this data for every year you have been in business. This way, you can demonstrate increases in cash flow over time and project future rates of profit.
2. Take stock of all your assets
Depending on the type of business you run, this could be the most tedious part of your valuation analysis. Make a list of everything you need to run your business. All employees, equipment, investments, and property play some role in generating profits. (If they don’t, it might be time to make some cuts!) From the total worth of these entities, you will need to subtract any outstanding business loans you are paying off, equipment loans, and lines of credit. Additionally, imagine how costs would change for a different buyer. Maybe you the owner are the primary manager, but a new owner might have to hire a manager. Be as detailed and thorough as you can in this step. If possible, have other leaders in your company look at your valuation to ensure that you have left nothing out.
3. Know the current and projected market research
If you are hoping to sell soon, you might get lazy and stop paying attention to trends in your industry. DON’T! Understanding your company’s value means knowing what potential it has to grow and adapt to a changing market.
Take stock of your industry overall and in your specific geographic area. Have a lot of new players entered the game recently, or has the competition stayed the same? If a new company were to try and break into the market, what barriers would it face? What gives your company its competitive edge when the competition increases?
Finally, even if the competition does not change, where is your industry headed in the future? How will new technologies, economic uncertainty, and changing consumer demands affect your ability to do business in one, five, or ten years? This information will help you know the multiplier which you should apply to your current cash flow. If big growth is projected, you will use a higher multiplier. (For more on this, see our previous article on Types of Business Valuation.)
What if you finish a valuation, and you don’t get the number you were hoping for? Don’t give up! In our fourth and final article, we’ll give you tips on how to improve your business valuation.
This is the final article in a series on small business valuation, where we’ve discussed the importance of and strategies to identify the exact worth of your business. Now we come to a tougher question: what if your valuation was lower than you had expected, and you need to increase it?
There are many different things that can increase your business’s value. Oftentimes the best strategies depend on details specific to your company, such as your industry, size, and geographic location. Here we will offer a few strategies that generally increase overall worth for any company.
1. Increase Profitability
While simply demonstrating profitability through your business valuation is important, buyers want to see that you’re on a growth path. Come up with new ways to cut costs or make your operation more efficient in order to give yourself a boost in profits.
2. Increase Scalability
If your business is “scalable,” this means profits go up as revenue increases. This is possible when costs are stable and do not increase significantly as the business grows. A scalable business is one with efficient and smooth processes.
3. Strengthen Your Competitive Advantage
Your competitive advantage is the reason that customers buy from you instead of your competitors. It may also be the reason your buyer chooses you over the other company for sale. If you are not sure what makes your company special, the best thing you can do is ask! Talk to loyal customers and ask them what keeps them coming back. Perhaps you offer the best customer service around. Maybe your product, though a little more expensive, is higher quality and lasts longer than the leading competitor. Whatever the case, play to those strengths as you seek ways to increase overall value.
4. Improve Your Financial Records
In conducting your business valuation, you may have discovered that your company’s financial records were not as clear or complete as they should be. This in itself is an indication of the company’s overall value. Incomplete financial reporting makes it difficult for potential buyers or investors to understand a company’s revenue stream. Even worse, it makes it look like the current leadership does not understand your own organization, which will raise concerns about mismanagement and the overall health of the operation.
Increasing the value of your company might require significant changes that will take you months to implement. Plan early so that you can make improvements long before you decide to sell.
Hopefully this information on the different types of business valuation and the steps to beginning one have helped you understand the importance of incorporating this process into your organization. Check out our previous newsletters for other tips on strengthening your company. Or shoot us an email and we’ll send them to you! firstname.lastname@example.org