Whether you are a company owner or an investor, you have certainly sat down and done your best to determine the business value. It’s the exercise that business analysts refer to a “Private Company Valuation,” which simply means determining the overall business value.
In many ways, determining the value of something essentially boils down to what someone is willing to pay for it. For instance, we’ve all seen transactions involving businesses, real estate or collectibles where market forces dictated a price that no valuation could have predicted, and no post-sales analysis can really explain. There are so many factors of consumer behaviour or investor psychology that are hard to pin down.
Key Factors for Determining Business Value
While there are certainly intangibles that go into somone’s willingness to pay, there are some hard numbers we can examine as we work towards a determination of overall business value. When you examine a company, consider these key factors.
Historical Earnings – How has the company performed in the past? What are the sales records?
Future Earnings Potential – Does the company have any new or potential contracts? Are there any new products ready for launch? Any market changes that would increase customer interest.
Accounts Receivable – It seems like every company is in this position – a low bank account, but a somewhat encouraging accounts receivable or “AR.”
Assets – Does the company own anything of value, including equipment, property, or products?
Customer Concentration – Does the business have a strong customer following? Specifically, are the contracts spread across a range of industries? Would one industry faltering bring the entire business to a halt?
Leadership Strength – A smart company concentrates on its people, and for good reason – they are the ones who make the decisions that lead the business into the future. As such, it’s important to look at the management team and assess whether it is capable of addressing future challenges.
Market or Industry Changes – Sometimes the real value will be determined by factors outside the company’s control such as changes to the marketplace or industry practices.
Company Reputation – We have mentioned it last, but in some ways, this could be the leading determinant of what someone is willing to pay. Is it an established brand? Will the marketplace recognize it as a dependable provider?
Approaches to Determining Business Value
When crunching the final numbers, there are a few different perspectives from which to consider business value. We recommend understanding each of these approaches to fully inform your final decision.
Cost or Asset-Based Approach – This is a simple and straightforward approach – just add all costs and investments dedicated to the business – then use that number as an indicator of business value. While this method may be quick, it doesn’t take into account things such as the company’s competitive reputation, market share, expertise, future earnings, or other key factors mentioned above.
Market Value – Anyone who has sold a home or a car knows this approach. The market value method compares your business to others that were recently sold. It is considered a reasonably accurate indicator of business value, but it’s often difficult to find businesses that are directly comparable.
Earnings-Based Approach – This is the most commonly used approach. The business value is determined by focusing on historical and future earnings. Of course, this approach is influenced considerably by management’s predictions of future performance.
Which approach to use for your final determination of business value? Our recommendation is that you use all three approaches to inform your analysis, and based on your experience and instinct, make a decision which is informed by the range of considerations.
Inform Your Valuation with Professional Expertise
If you are determining business value, either as a seller, potential buyer or investor, seek an outside opinion on the calculation. Determining business value is complicated and experienced professionals may get closer to the mark. They can review your financial performance, provide an industry outlook and propose strategies to enhance the market value of your business.
Your Turn
In your experience, what factors drive business value?
In your opinion, are any particular factors surefire indicators of business value?
