Managing Director, David H. Crean, Ph.D, serves as a Forbes Council Member providing M&A thought leadership and insights for business owners. This article was originally published on Forbes.com on November 14, 2019 at 8:00AM PST.
When it comes time to sell a business, business owners should know their minimum target sales price in order to achieve their exit goals and fund the next stage of their life or business goals. Determining the market value of a company that publicly trades on a stock exchange is a formulaic product of the company’s stock price and its outstanding shares. For private companies, however, the process is not as straightforward and involves various methodologies.
How To Value Your Business
The most common method of estimating the value of a private company is to use comparable company analysis. This approach involves searching for companies that are publicly traded that most closely resemble the privately held company. The process includes researching companies of the same industry (ideally a direct competitor) and a similar size, age and growth rate. Averages of the publicly traded valuations can be calculated to provide a sense of where the private company fits within its industry.
The EBITDA multiple is another method used that can help in finding the private company’s enterprise value, which provides a much more accurate valuation because it includes debt in its value calculation. Also, if the company operates in an industry that has witnessed recent acquisitions or initial public offerings (IPO), the financial information from those transactions can be used to calculate a company valuation.
The discounted cash flow method is a final alternative to value a private company. The first step involves estimating the proforma income statement over several years and discounting the free cash flows based on weighted average cost of capital (WACC) as well as other potential business or technical risks. This can often be a challenge for private companies due to the company’s stage in its lifecycle and management’s accounting methodologies. Often, an illiquidity premium can also be added to the discounting to compensate potential investors for the private investment.
As you can surmise, the valuation of a private company is full of assumptions, best-guess estimates and industry averages. Compounded by the fact that there is a lack of transparency involved in most privately held companies, it’s often a difficult task to place a reliable value on such businesses. While no two companies will be identical, by consolidating and averaging the data from the various analyses, you can reasonably estimate your firm’s value.
How To Improve Business Value
There are several ways to make a business more valuable to buyers.
1. Increase profitability. Buyers are willing to pay more for companies that generate cash flows and profits. Furthermore, if the profitability is increasing over time, there will be greater competition for your business and buyers will be receptive to paying higher prices. Business owners must look for ways to cut costs or create efficiencies that will give their businesses increased profit margins leading up to a business sale.
2. Acquire recurring revenue agreements. Owners should consider ways to consistently increase revenue, with special attention on recurring revenue sources that generate income immediately. Implementing a recurring revenue business model guarantees stable, predictable income and a high customer lifetime value. Building recurrent streams will give buyers assurance that they will have a consistent revenue flow when they take over the business.
3. Increase customer diversity. Put another way, decrease risk for a buyer by decreasing customer concentration in the business. To the extent it is possible based on the type of business, the sensible strategy is to spread revenues across and within vertical markets and geographic areas.
4. Differentiate your products or services. Differentiation is an important priority for any firm, whether seeking new investors or a sale of the business. Companies with differentiated products or services usually command a premium price based on unique positioning in the marketplace that provides advantages over competitors.
5. Get your financials in order. It’s important that business owners keep track of financial records in a quality manner and compare them year over year to highlight fiscal health of the firm. If issues have been identified and are not repaired, they could hinder the sale of the company or reduce the purchase price. Remember, numbers don’t lie. Worthy buyers will scrutinize the business financial statements, so you need to be prepared.
6. Create a succession plan. Proper succession planning is critical to the sale of a business and should begin on day one of ownership, if not before. Buyers want to know who they need to retain and look to for post-acquisition integration so they can continue to successfully operate the business after the sale.
7. Develop seamless processes. In many cases, the most valuable asset in the purchase of a company is the seller. Develop airtight processes and routines that enable the company to function effectively without the seller’s direct involvement. Make sure these processes are also documented so the new owner essentially has a guide to running the business successfully.
8. Retain key employees. The last thing a new owner wants is employee turnover. Skilled employees bring stability to the business and generate real value for the company. By actively cultivating a high-quality workforce, you can increase the company’s worth, especially if employees are committed to remaining with the company after the business owner’s exit. Build long-term incentives for key employees, such as equity ownership that vests over time or bonus plans tied to profits that motivate key employees to stay on after a business sale.
So, asking important questions on company worth and ways to increase its value is critical for any business owner and entrepreneur of any size company. For investors, company valuation is a critical component in determining the potential return on investment and if the company is fairly valued at the time of the investment. And like most complex mathematical problems, it depends on a variety of factors. Understanding the value of the company is important as the business grows and approaches liquidity situations such as a business sale.
To read the article in Forbes, visit: https://www.forbes.com/sites/forbesbusinesscouncil/2019/11/14/how-to-determine-your-companys-worth-and-increase-its-value/#601324766e9f.
About the Author:
David H. Crean, Ph.D, MBA
Managing Director, Life Sciences & Healthcare
25+ Years of Experience
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