11 Reasons You Might Need a Business Valuation
If you’ve owned a business for a while, then you know practically everything about it. After all, it is your company, and who’d know it better than you?
While it’s a given that you have a lot of information about your company, do you know how much it’s worth? For example, if a potential buyer approached you and made a ballpark offer, do you know if you are making a gain or underselling?
Sadly, most business owners fail to get their businesses valued. This is because they do not see the need or would rather not spend money. However, you require a business valuation for many reasons, including during mergers and acquisitions.
Therefore, this article will share 11 reasons you should get a valuation for your business. But before getting to that, what is a business valuation?
A business or company valuation refers to the system used to determine how much a company is worth. For this to happen, a valuation professional will have to be appointed to examine different aspects of your business.
Conducting a valuation ensures that you sell your business for its worth. In addition, a business valuation is helpful for buy-sell agreements; creating partnerships; for personal reasons like family disputes, and sometimes the tax authority requires it.
Business valuations are usually driven by various factors such as:
- Product and service offering
- Markets and geographies in which your business operate
- Revenues and cash flows
- Potential to deliver value in the future (future cash flows)
- Intellectual property
- Strong customer base
- Growth potential
- Strong management and employees
- Systems and processes
- Barriers to entry
Also, there are different valuation methods, which include the following:
- Liquidation value
- Earnings multiplier
- Market capitalization
- Discounted cash flow
- Times revenue method
- Book value
Now, aside from knowing the worth of your business, you enjoy other benefits when you perform a valuation. For instance, it shows you how your business is growing, and you can use it to compare your company’s performance to that of your competitors.
Let’s now discuss why you might have to get one for your business.
Below are 11 reasons why you may require a business valuation.
You must make informed choices at different stages in your business and create better strategies. Conducting an evaluation makes this possible, especially if you are about to make significant changes or decisions about your company.
The decision could involve your personal life, but one that would impact your business. Therefore, you should perform a valuation when trying to develop a new business strategy, decide whether to buy a new business, expand the one you have, or give it out as a gift.
To expand and grow your business, you need capital (inflow of cash). While you can apply to the banks for a loan, you might also want to give people an opportunity to invest in your company. In either of the two scenarios, you need to conduct a valuation.
Many start-ups and small businesses require ongoing capital infusion to help them grow and sustain. Every time you raise a round of capital, you will need a business valuation to be performed. Your business’ value is one of the key terms in your investor term sheet.
Investors also want to know the value of your business and what they stand to gain if they put their money into it. This is more so if the investors want a substantial stake in the company.
You are more likely to gain the attention of an investor when you showcase your business’ potential, and its valuation increase over time. They will be able to see that their money will catapult the company to the next level, and increase its value.
A buy-sell agreement shows how partners in a company or partnership will get the shares of a partner that leaves the company. Leaving could either be by free will or retirement or through death. This document is vital because it helps to avoid quarrels over the shares.
A buy-sell agreement also comes into play when a business gets a new partner. Irrespective of why the contract is needed, it is crucial that each party feels they are getting their money’s worth. If your business is a partnership, you will have to perform an evaluation for transparency’s sake.
The report, among other things, will list the factors influencing the price of the shares at the time. This way, the person buying, or selling does not feel they are paying more or receiving less.
Whether you want to set up an ESOP or determine the value of existing shares, you must conduct a business valuation. ESOP business evaluation happens yearly, and it helps you to measure what you and your staff have achieved or create new determinants for employees to become part of ESOP.
ESOP gives employees ownership rights in the company by assigning shares to them. Generally, public limited/traded companies use the current market value of their shares for ESOP. As a private company, you need a valuation professional to evaluate how much you can receive as shares contributed to the plan from employees. The valuation also shows how much the participating staff can get in yearly dividends.
You must perform a valuation if you want to give back to your community or a charity organization through your business. This is because the tax laws in some countries require donating businesses and the receiving charity to provide details that show the right of a taxpayer to deduct money given to the charity.
Businesses seeking stock options and other non-qualified deferred compensation must perform a valuation. When your employee exercises his/her options, a business valuation is required to determine the fair value of the stock being issued. If you fail to perform a valuation on the stocks given, there will be consequences in the form of taxes and other penalties.
If you want to sell a business, then you must perform an evaluation. Doing this will help you determine your business’s baseline value and create a strategy to increase profits before the sale. Then, by increasing your company‘s profitability and other underlying metrics, you improve your business’ value.
Also, a valuation helps you know what price to ask for from potential buyers. In addition, it helps you decide whether you should sell at the time or push the sale forward by months or years. This is one of the most common reasons for business valuation exercise.
Whether you are involved in mergers and acquisitions negotiations, a managerial buyout, tax planning, or re-organizing your company, knowing your business value is an integral part of the process. This is because it helps appraisers develop a fairness opinion.
A fairness opinion covers a business transaction’s complete review from a financial viewpoint. Usually, a valuation professional will examine the price set for the business, the terms and conditions to decide its fairness, and whether it is acceptable to the minority shareholders from a financial viewpoint.
There are legal battles that call for the valuation of your business. They include family disputes, estate disputes, minority shareholder actions, etc. Many of these litigations are painstakingly slow. In any of these examples, the company valuation will answer one question: how much is the business worth?
Buy back of shares refers to the company that issued them repurchasing them. Buy back of shares has become a means of financial/capital restructuring in recent times. Buy back of shares also help in improving key ratios, as well as act as a protection from potential takeovers. In 2022, the share buy backs have increased by 170% as compared to the previous year. Investors see share buy backs as a positive sign, showing the confidence of the management in the underlying fundamentals.
If your company is a private company, then arriving at a valuation for the purposes of this buy back becomes a complex issue. It is usually required to establish the fact that the shares have been bought back at the Fair Market Value (FMV)
Finally, if you plan to retire early or are close to retirement, part of your exit strategy should be performing a valuation. Conducting company valuation is important if you want to sell your interest in the business or hand it over to a managerial team.
As a business owner, you must always think ahead and know what your next action will be. Regularly evaluating your business will keep you informed and help you make better decisions. But ensure you hire a valuation professional to handle the process.
For more information on how to conduct a business valuation, contact us.