At some point, every business owner needs to determine the value of their company.
Maybe you’ve launched a new tech startup and are taking on investors, or need capital to grow your established business. Perhaps your long-time business partner is thinking of leaving and you need to know what their shares are worth. Or maybe you’re thinking of selling and want to know how much you can get for the business you’ve worked so hard to build.
The process of completing a business valuation seems straightforward on paper, but in practice it can be as much art as science. As many people discover the hard way, it can also be a very emotionally charged experience. With that in mind, here are a few tips to get you started.
Best advice: Find an expert
When determining who is going to do your valuation, make sure they are qualified and have an ‘outside’ perspective.
“Bring in the experts,” says Mike Davis, Senior Vice President for HSBC’s Corporate and Commercial Banking for the Prairies. “When you sell your house, you bring in a real estate broker who knows the market and who can tell you what small changes you can make to maximize the selling price. You should do the same thing when you are selling your business. Most accounting firms will have a group of people focused on mergers and acquisitions who can set value expectations and who can help the seller maximize their sale price.”
“Start early and get lots of advice,” suggests Kristi Miller, the National Managing Director of First West Capital. “Don’t try and do your own valuation. You need an outside perspective, so start by turning to your outside accountant. Your in-house accountant will be biased, and might not have the market knowledge needed.”
“The practice of business valuation in Canada is not regulated or licensed by any government authority,” cautions Robert Boulton, the Executive Vice President and COO of the Canadian Institute of Chartered Business Valuators. “Anyone who is intending to rely on someone telling them what a business is worth needs to make sure that such a person is qualified to do so. Chartered Business Valuators are. They’ve completed our extensive education program, passed a comprehensive membership examination and have experience performing business valuations.”
How business valuation works
The actual process can be straightforward.
“The first step in the process is for the valuator to meet with the business owner in order to understand the situation,“ explains Robert Boulton. “Then they will gather information about the business in order to analyze it and make an informed assessment about the cash flows that will likely be generated from future operations, and the capital investment required to generate those cash flows.”
Then, says Mike Davis, “Get your house in order. Make sure your financial statements are up to date and accurately reflect the value of the underlying assets and liabilities. Future projections should be reasonable, based as much as possible on existing or contracted business and easy to verify with third party information.”
What the pros are looking for
Depending on whether it’s a startup or an established business, the experts involved will look at different factors.
According to Mike Davis of HSBC, “The main considerations looked at by banks are the type of assets, like real estate and equipment, intangibles like patents and goodwill; the quality of the assets – are they worth what the seller thinks they are? Can the company generate consistent operating cash flow? Stability is a factor – stable businesses are generally better, but fast growing businesses can generate a higher purchase premium if we are certain the growth is real.
"Then there’s market position. All other factors held constant, market leading companies are generally worth more than their competitors and companies that are highly dependent on one supplier, who could increase their costs and squeeze our company’s margins, are worth less. Then there’s level of debt, since the purchase price equals the value of the company minus its debt.”
Valuating a startup looking for equity investors is a very different process than looking at an established firm, because there generally isn’t the cash flow and track record to turn to.
“There is no real scientific formula when it comes to valuating startups,” says Sean Burke, COO of FrontFundr, which connects entrepreneurs with early stage investors. “It’s really about the ability to identify what the risks are and what the possibilities of the market are. Looking at the key business objectives, the team and – based on the stage of the company – looking at comparable businesses in their industry.
"People are investing in the idea and the market potential, but the main factor is how the management team is going to get their objectives met. Do they have a good growth strategy? Is their plan realistic, and will it get them through to their next milestone?”
How long does a valuation take?
The time involved in completing a valuation can be longer than people think.
“It can take a few weeks up to several months,” says Robert Boulton. “The timeframe depends in part on the complexity of the business being valued, the purpose of the valuation report and how quickly required information is provided.”
You also need to leave enough time for the process that’s led you to do the valuation in the first place – like raising equity or selling so that you can retire.
“You need to plan ahead, and give yourself time,” says FrontFundr’s Burke. “Too often companies come to us and say ‘Hey I need to raise money now!’ but it really can take months to structure your initial raise and get everything ready. You need to build your list of potential investors, get your plans in order and gain traction in the market.”
“If you’re planning on selling your business, you need to leave lots of time for estate planning and getting your tax situation right,” says Kristi Miller. “As well, one of the first things your advisors will need you to prove is that the business can exist without its founders. So sometimes the first step in the planning process is to recognize that the founder is too involved and needs to step back. That might involve hiring a CFO, or taking other steps – and that can take months.”
Be realistic and objective
You also need to prepare yourself for the results of the valuation. Because business founders can have unrealistic expectations about what their company is worth.
“A lot of people think that the value of their company equals the annual income they want to have in retirement times how many years they plan to live. That has nothing to do with the real world,” says First West Capital’s Kristi Miller. “You also have to remember that value and price aren’t the same thing. You might think your business is worth $25 million, but in a down market it’s only worth $5 million.”
Many people’s self-esteem becomes very tied to their business, so accepting the hard facts can be difficult. What do you do if the results of your valuation aren’t what you’d hoped?
“If you can’t get the price you want, either don’t sell and wait it out or be willing to sell at a lower price – or at terms that are less advantageous,” says Miller. “That’s why I recommend that people start early, take a lot of time to work through the process, and have realistic expectations.”
Startup founders can often be very passionate about their new business’s potential, and that can cloud their judgment about what their early-stage firm is worth.
“With startups, you’re doing a valuation in order to understand how much of the company you need to give up now to get the cash flow you need to take it to the next level,” says Burke. “You need to be realistic.”
Many times, people are seeking a business valuation because they’re thinking of leaving the business they founded, which adds an extra layer of emotional complexity.
“Think about what you want If you’re selling, think hard about why you’re doing and what you want out of it. Are you really ready to retire? Are you ready for what comes next?” asks Miller.
The bottom line advice
Go into the process with your eyes wide open and be willing to take a hard, objective look at your business and the reasons why you’re doing a valuation. The experts weigh in on their parting piece of advice for business owners:
Sean Burke, FrontFundr: “It’s never too early to get started. If you need money in a year, get started now. Know why you’re raising money and make sure you lay the right groundwork with solid initial structuring and planning.”
Mike Davis, HSBC: “Don’t be afraid to walk away. Don’t get caught up in the process. If something does not look or feel right – walk away.”
Kristi Miller, First West Capital: “Start early. Get good advice. Think about what you want and why you’re doing this. And remember that value and price are not the same thing.”
Robert Boulton, CICBV: “Make sure the person doing the valuation has the experience and training necessary to do a good job. Business valuations are not just number crunching or as simple as applying a multiple to recent earnings. It takes thoughtful analysis to arrive at a conclusion that is meaningful and useful.”
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