Business Valuation – The Best Way to Start A Strategic Conversation with Business Owners
I regularly quote Steve Covey’s second habit, “Begin with the end in mind.”, and I still think that is the single most important lesson for business owners. But at the same time, it is very difficult to work towards the end if you don’t know where you are starting from. In business that’s a detailed business valuation report. What is the business worth? What is driving that value? Can we improve it? What changes have the most impact?
I often hear people talk about business valuation being more art than science and put simply that is absolute rubbish, done properly, business valuation uses detailed financial and risk analysis to determine the appropriate valuation for your business. The reason people refer to it as being art is they don’t understand the process and analysis involved.
Business valuation is really trying to work out two key things (the same things that you need to work out when valuing any other type of asset) and that is return and risk. Return in a business is the profit that you make – what return can I expect from my investment? The part that most people refer to as art is estimating the risk of that return continuing. We use detailed risk analysis tools to calculate the appropriate risk bringing into play macro-economic factors, industry drivers, and business risk within the business being analysed. This means we can come up with a risk score that provides an appropriate multiple.
In terms of some of the key terms used in a business valuation, below is a list of key definitions:
- Multiple – what factor (based on risk) do I multiply the annual profit to get the goodwill value?
- Goodwill value – the ongoing value of the returns produced by the business (not the underlying assets).
- Intangible value – many businesses create substantial value on intangible assets like the brand (think Apple or McDonald’s), some unique intellectual property or secret process (think Tesla).
- Equity valuation – this is the Goodwill value of the business plus any cash less any debt – in other words goodwill plus net tangible assets.
- Value drivers – in all businesses there are significant levers you can pull to improve value – some work better than others and getting the order right makes a big difference.
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