What Is My Company Worth?
by Alan J. Smith December 22, 2003
One of the most mystifying concepts in the ownership of a private firm is what the business is actually worth. The majority of private company owners have very vague ideas. Considering that most owners have the vast majority of their wealth tied up in the firm, it would make great sense to better understand what the value of the company is and how that value will be affected by numerous drivers and events.
Certainly the greatest influence on the value of the company is the organization itself but significant impacts such as the general economy will play their part. There are also elements involving specific buyers when an owner decides to sell a company. It is clearly evident to me that the value of a business becomes higher when it is in the hands of a buyer who brings along the resources to capitalize on the existing business. This may be capital, distribution capability, technology, management know how or anything else a buyer can leverage to the business for better results and profitability.
Knowledge of a company's value is power. It's power because it provides a reality check and a factual basis for understanding where the company stands financially and what its options are. Far too many owners wait until they are considering the sale of their company to have a formal valuation done. My experience has been that when an owner waits until the company is for sale before completing a valuation, they find a lot of information that could have been very helpful over the years building the business for a higher value. Just don't let that happen to you.
We strongly urge our clients to have a formal valuation completed and reviewed on an annual basis. A detailed, professional valuation consists of much more than just providing a number or range of values. It should include a myriad of value drivers that relate to the company. It also allows the client to understand the approach that is used and why it is appropriate for the particular company. It's not uncommon for it to be a blending of methods with assigned weight given to each method. Valuation methods typically fall under one of three basic valuation models: the asset approach, the market approach, or the income approach.
The asset approach uses appraisal methods that consist of a review of the individual assets of the company. In this method, assets and liabilities are adjusted to fair market value.
In the market approach the valuation professional identifies a number of sale transactions of companies comparable to the business being valued. By analyzing the relationship of numerous financial factors to the purchase price, one can develop ranges or averages to apply to the same financial measure of the business being valued.
Another method used in valuing a business is the income approach, also known as the discounted cash flow approach. To apply this method, the company's cash flow is projected for a select period, often three to six years, and a terminal value estimated. A discount rate is applied to determine the present value of the total projected cash flow for the selected period, with the discount rate adjusted to reflect the uncertainty of projected outcomes.
The single biggest reason for an owner to do an annual valuation checkup involves the previously mentioned value drivers. It allows the owner the opportunity to understand what the value drivers are and how they negatively/positively influence the value of the company. In general, there are 4 types of common value drivers:
Intangibles, Operating, Investment, and Financial.
- Owner's particular product/services knowledge
- Management's knowledge, experience and depth
- Motivated and dependable work force
- Key employees bound by non compete agreements
- Management succession plan in place
- Long history, reputation and name recognition
- Management focus on growth and value creation
- Business plan is regularly monitored and updated
- Loyal customers
- Few Competitors
- Strong supplier relations
- Reputable company advisors
- Active and visible in community and industry affairs
- Repeat Customers- customer list
- Proprietary products: patents, copyrights
- Recognizable trademark or trade name
- Diversified: products, customers, geographic (size)
- Exclusive distributor/supplier rights
- Special operating procedures and trade secrets
- Favorable location to customers and suppliers
- Market Intelligence systems in place
- Industry specialization
- Unique manufacturing/production process
- Creative use of website to sell product or services
- Strategic partnering and alliances
- ISO 9000 registered vendor
- Commitment to human capital (training, benefits)
- State of the art technology equipment
- Large inventory selection (size)
- On-going investment in information technology
- Additional capacity for growth (space, manpower, etc.)
- Commitment to research and development
- Capital budgeting processes in place
- Key management have incentive compensation plans
- High margins due to efficiencies, etc.
- Strong liquidity position
- Optimal financial leverage
- Optimal operating leverage
- Favorable tax structure
- Properly insured against external risks
- Long-Term profitable customer contracts
- Purchasing power (size)
- Favorable lease terms
- Favorable debt financing terms
- Financing plans in place to secure needed capital
- Funded buy-sell agreement
- Systems in place to comply with laws and regulations
All of the above factors, and many more, will be closely considered in a detailed, professional valuation. These are the core ingredients that the savvy owner will analyze and use to improve the company, and in the process, build a company that will continue to become more valuable. At the end of the day the success of the business is ultimately measured by the value the business. Alan J. Smith is the President and Founder of Bay Pacific Group, Inc., a boutique mergers and acquisitions advisory firm representing privately held middle market companies. Alan can be reached at 415-420-1696 or emailed at firstname.lastname@example.org. The company website is www.baypacificgroup.com.
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