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5 Technical Business Valuation Concepts Every Business Owner Should Know

charts representing the valuation of a business

“How much is my business worth?” is a common thought among entrepreneurs and business owners, especially if you are looking to sell or thinking of succession planning. Yet, determining the value of a business is not an easy exercise, despite many available “rules-of-thumb” multiples of sales and earnings. Determining a company’s value is as much of a science as it is an art, and each situation is different. The same business may have a different worth to each shareholder, for example, depending on their share structure, business involvement and relationships with other shareholders.

While this post will not discuss the complexities, it will discuss the important concepts a business owner ought to know when thinking about business valuation and considering employing the services of a professional business valuator.

  1. Business “value” can be determined in the context of “open market transactions” or “notional market valuations”

The term “value” carries a lot of meaning, and it does not always equal price. “Value” is in the eye on the beholder, while price is determined by the market (what the seller is willing to pay for and what the buyer is willing to accept). Open market transactions are essentially those that have been completed on the market (a place where transactions are facilitated between buyers and sellers). This means that once the buyers begin soliciting offers, the business interests are exposed for sale to the open market; once sold, it is an open market transaction.

Notional market valuation, on the other hand, produces a theoretical value and is determined without exposing the business for sale in the open market. When a professional performs a notional market valuation, their professional judgement is used to make sure the notional market valuation mirrors open market transactions for a more precise valuation.

  1. There is a variety of methodologies to value a business…

One of the main questions one should ask themselves before wondering about the value of their business is whether their business is a going concern. Meaning, at a point in time when you are wondering about the valuation, is your business going to continue its operations into the future? While there are a lot of technical nuances associated with the above question, in general, if the answer is yes, the valuation methodologies that are suitable for a going concern are both income-based and market-based. If the business is not considered to be a going concern, the business should be valued using the liquidation methodology utilizing an asset approach.

  1. …and it is all relative!

Why is it relative? Well, the choice of valuation methodology depends on many factors, but it is generally all relative to business type, business stage, financial position, and the circumstances for the valuation. For example, if you have a food equipment business that has been operating profitably for over 20 years, and are looking to sell, an income-based approach is a good candidate. Now, imagine the same business, but instead of considering selling the business, the valuation is to be done for tax purposes—be it reorganization or an acquisition—then, suddenly, a variety of other methodologies may seem like a better fit.

There are more valuation methods, but they are a lot less common.

  1. Each valuation methodology has different approaches which require various level of detail and analysis

For simplicity, we will only focus on income- and market-based methodologies.

For income-based valuations, the most common approach is a discounted cash flow (DCF) approach. It is known as “intrinsic valuation” and is performed by building a financial model. It forecasts the business’ cash flows into the future and uses a specific rate to discount these cash flows to produce a valuation at a point in time; this is a notional market valuation approach.

A market-based methodology, on the other hand, is known as relative valuation; this is based on the open market transactions; the most common approaches under this methodology are comparable company analysis and precedent transactions approaches:

The comparable company analysis approach is done by comparing the current value of a business to other similar businesses by looking at trading multiples like P/E, EV/EBITDA, or other relevant industry ratios.

The precedent transactions approach is performed by comparing the business to recently sold or acquired businesses in the same industry. This methodology is similar to the comparable company analysis, except it is based on the transactions and may include a purchase premium included in the price for which they were acquired, depending on the circumstances of the sale.

  1. Each valuation approach may produce a different value

This is the fun part of valuation: each of the above approaches may give a different value, and with that, a value range is produced based on expert judgement. Often, valuation professionals will triangulate the range of values from comparable valuation, the range from precedent transactions, and the DCF valuation model to get an approximate average value incorporating each of the methods.

Know When to Hire a Professional

There is really no “right” way to value a business – it is all relative, similar to Albert Einstein’s theory. The truth is, your business is special, and you have worked hard to build it – so why would its valuation be as simple as multiplying your business’ EBITDA or Sales by a multiple? This is why it is so crucial to engage a professional to discuss how to go about doing this – and our professionals can help.

Talk to the professionals at Sloan Partners LLP about how we will make it easy for you to gain an insight into how to maximize the value of your business, be it for your financial retirement fund or for your business growth. We will make sure all your needs are met. Contact us online or by telephone at 416-665-7735.

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