Do you need investors or want to sell your business to a potential buyer? Many factors can affect your business’s market value, and this is where a Chartered Business Valuator (CBV) plays an important role.
There is a saying that “the value of a business is only what someone is willing to pay for it.” As a result, you need to keep in mind that your business’s valuation, even when done by a specialist, is only a starting point for negotiations.
The valuation of a business is not an exact science
In addition to the monetary value calculated according to accounting principles (assets) or operating principles (cash inflows and outflows), two other financial projection variables must be taken into account. The risk factor, which is evaluated in relation to the market and the industry’s economic context, as well as the estimated rate of return for the coming years.
Whether the valuation is undertaken for an investor looking to recover his or her investment while making a reasonable profit, or for a buyer looking to validate the potential for longer term profitability and growth, the approach will be the same. However, each method’s result will be different, which is why it is better to validate using more than one method, and above all, to leave this tedious task to the experts.
The different calculation methods used
Regardless of the calculation used to determine the market value of your business, the goal remains the same. The objective of business valuation is to translate all factors into a single representative amount and develop a hypothetical but realistic portrait of future earnings. Valuation techniques therefore seek to capitalize either assets, cash flow, or profits.
Asset-based method: The book value as validated by financial statements, which is the current net value based on shareholders’ equity (real estate, equipment, inventory, etc.). The net asset value is called “adjusted” when all the business’s liabilities are subtracted from the amount.
Income and cash-flow based method: The current value of the business based on cash inflows and outflows. The value obtained is based on operations. The term “discounting cash flows” is used when a rate of return is applied to fluctuations, i.e. a more or less long term estimated financial projection.
Bear in mind that a valuation based on cash flow is preferred by investors. It is more concrete and precise and the risk is easier to evaluate. Even if you are starting your business, this valuation method will take into account the possibility of short-term losses while determining the growth potential of returns in the longer term.
Profit-based method: Earnings analysis before interest, taxes, depreciation, and amortization (EBITDA) is the method most used by experts. Ideally, it is calculated over a period of at least three years. A range of factors then determines the multiple applied to the obtained amount in order to establish the market value of the business. Other factors, such as the size of the business and the type of industry, also influence the result. As a general rule, if EBITDA is multiplied by a number:
- Below 3, this often means that the company has significant shortcomings and it is therefore risky to invest;
- Between 3 and 5, growth prospects are considered favourable;
- Greater than 5, the company is very well established, often has more than one branch, has a proven track record, and is an excellent investment.
"We consider all the positive and negative aspects that may affect the company’s ability to maintain future earnings. The higher the risk, the lower the multiple. The ratio is inversely proportional."
Factors that influence the value of your business
It is important to know the value of one’s business in a number of cases, not only for the sale of a business. These situations could include preparation for succession or retirement, efforts to avoid disputes and conflicts between shareholders, or the protection of your company’s intellectual property.
By taking a look at the factors that influence the value of a business, it is easy to understand why an external valuation is essential
. As part of his or her involvement, the Chartered Business Valuator (CBV) can identify weaknesses and help you build on the right elements to increase your business’s value.
- Market conditions and the economic context of the industry
- The company’s location
- Value of fixed assets
- Intellectual property
- Expertise and know-how (even though intangible)
- Order book, regular mandates
A business valuator to increase investor or buyer confidence
Governed by the Canadian Institute of Chartered Business Valuators (CICBV), a CBV will use the EBITDA method and can objectively establish the actual market value of your business. As a result, the valuation creates buyer, investor, and financial institution confidence. You can get three types of reports according to your needs:
- Calculation report – rough estimate (value of $3,000 or more[*])
- Estimate report – for negotiations (value of $4,500 or more[*])
- Comprehensive report – high risks or important issues, i.e. litigation (value of $10,000 or more[*])
This type of expert represents a major asset not only during the valuation, but also when you receive an offer for the purchase of your company. The valuator can tell you if the offer is reasonable. Don’t have any buyers? Your CBV could tell you where to look next.
What about the value of expertise and know-how? The knowledge you have of your company, industry, suppliers, and customers can be a great guarantee of success for the buyer. Take the time to negotiate the transition terms, including the time you will devote to the transition and the compensation you require.
Need advice before taking steps to sell your business?
» Contact the Acclr experts at the Info entrepreneurs Resource Center.