It starts with a Business Valuation
I’ve decided it’s time to retire. How much is my business worth?
How much do you think it’s worth?
I really don’t know but, if I had to guess, I’d say around $2.5 million.
Well, uhhhh, actually, you might find that if we did a valuation of the business, it may only be worth about $500,000.
That’s impossible, I can’t retire on that…
The fact is most business owners don’t think about what their business is worth until it’s too late. The vast majority of owners don’t plan for the sale of their business.
These owners don’t think in terms of selling their business at some point in time. Frequently, they view the business as a vehicle that provides them with an income and there is a rather fuzzy thought or picture involving a sale to fund their retirement.
For most business owners their business is the single largest asset they have.
At the time of retiring, the average business owner in Australia does not have a funded pension beyond what they have set aside in their own and their spouse’s Superannuation, most will have a personal residence that has only recently had the mortgage paid off, and less will have a significant investment portfolio.
In many situations your business will be the most significant financial asset.
You should be asking yourself these questions:
- Do I really know what my business is worth?
- Have I had a business valuation prepared recently?
- Do I know what factors drive the value of my business?
- What things should I be doing right now that will influence the value I receive when it’s time to sell?
- Should I be making some provision for the business in my retirement planning?
Yet, the number of business owners who still either do not know or who have the wrong idea about the worth of their businesses is surprising.
For the most part, this is because these owners do not place much stock in having business valuations done regularly, or at all.
After all, why should they dedicate significant time and resources to a business valuation when they are not ready to sell their business?
Why would you be interested in knowing the true value of your business when you are making a profit year after year?
Sounds perfectly logical.
But sometimes what seems logical, blinds you to opportunity, and to risk.
As a business owner, you need to understand what a business valuation is and why it is important for your business to have one done. Additionally, knowing when to have a formal valuation done could influence the direction and internal decision-making of your business.
Below we discuss some of the reasons to have an accurate and compliance business valuation and how often to do it.
What is a Business Valuation?
Each business has a value attached to it.
Customers, competitors and even shareholders rate the performance of a company based on its worth. A business valuation is a value assigned to a business after extensively looking over the financial documents, strategic direction, aims and goals of the business owners, the structure, the amount of time the business has been operating, and various other industry related variables.
Business valuations differ from estimates of a business’ worth in two main ways.
First, a formal valuation is typically conducted by external, qualified, business valuers, though in some instances a CPA/CA can value a business.
The second, and more significant difference, between a business value estimate and valuation, is that unlike the estimate, a business valuation takes more time to conduct and is both more extensive and intensive than an estimate. Where an estimate may only consider the financial figures in determining the value of a business, a formal business appraisal investigates the non-financial side of the business as well.
Why conduct a Business Valuation?
A business valuation plays a major role for lenders, business owners, potential investors, shareholders, and numerous other parties tied to a business.
Each of these parties has an interest in the worth of the business.
An investor would want a business valuation conducted to make a decision whether to invest in that venture or seek out a better opportunity.
For a business owner, an appraisal carried out by professionals could make the difference between one asking price and another when selling the business.
Because conducting formal valuations takes time and money, how often a business is appraised typically depends on two main considerations: the purpose of the valuation, and the succession plan for the business.
How often should you formally appraise your Business?
Should you ever take the time to look up how often companies are valued, you will notice that the period differs considerably.
Businesses have valuations done depending on their budgets and reasons for the same. If you are a business owner, stakeholder, investor, or lender, and you are not sure how often the business you are associated with should be appraised, consider the following factors.
Business valuation for perpetuity
Individuals start companies for a variety of reasons and with various retirement plans in mind.
For example, a man could start a hardware store to provide for his family and then decide to leave the business to his progeny. In this case, the line of succession within the business would be hereditary. Others start or join businesses to act as their retirement plans.
Investors fund companies to enjoy investment benefits upon retirement.
Many business owners develop products and grow their businesses so that they can eventually sell them.
The plan of succession for a business determines how often the company will need a business valuation.
A business that has a succession plan that ends with the sale of the enterprise may need a business valuation less often than most others.
On the other hand, if you intend to keep your business, you will need to appraise it annually, or biannually, preferably annually. The frequency of the formal valuations will depend on the complexity of your business operations as well as the availability of resources to facilitate the appraisal.
Frequent valuations will help you keep track of the financial state of the company:
- How much profit have you made?
- What are your profit margins?
- Are some areas of your business more profitable than others?
- Are you outperforming your competitors?
- What is your company’s cash flow trend?
Having the answers to questions like these through conducting a business valuation helps a business owner to make sound informed business decisions. The same goes for other parties with a vested interest in the business.
Valuation frequency depending on purpose
Conducting valuations depending on the succession plan provides interested parties with a fairly regular overview of how often to have them done.
However, sometimes as a business owner you may have to conduct business valuation under specific circumstances, in which case, it is harder to predict the frequency of the appraisals.
These circumstances include, but are not limited to:
- When there is a dispute in the company and a valuation is necessary for dissolution
- When a partner decides to leave the firm
- When a valuation becomes necessary for estate planning
- When the company comes under legal suit
- When a valuation is necessary for strategic planning of the business
- Evaluation if you have the right level of insurance or paying too much
- Assistance with a divorce settlement
- When you need to raise capital for the business
- Relocation of the business
- Debt restructuring
In these cases, the frequency of valuations varies. The number of formal valuations the business will need could be as few as two every ten years or as many as one every year in some cases.
Consider your opportunities and envision possibilities
Think about your business as an investment, just as you would your shares although there are some big differences between your business and publicly traded shares.
Two of the biggest differences are:
- There may not be a ready market for your business, and
- The market price for your business can vary significantly depending on the purchaser you are able to attract.
If you want a business valuation for a business, the best option would be for you to hire a professional business valuation company to handle the appraisal for you. These are specialists who will not only place a value on your company but also guide you through the process.
Having a formal valuation is also a great way to attract and reassure investors and potential buyers of the validity of the worth assigned to your company.