Business owners frequently ask what their business is worth – and for good reason. For many business owners, the majority of their net worth is tied up in the value of their businesses. It’s a difficult question to answer – because the truth is that the value of a business depends on a large number of variables that are changing constantly. Just like the stock market adjusts the price and value of publicly traded companies each and every minute – the value of private companies is also changing due to market moving forces. We can’t visualize or see the valuation changes on a scrolling ticker for privately held companies, but their values are still changing constantly. It also may not be the right question for most business owners to ask. Instead of asking “what is my business worth?” let’s reframe the question and ask “what drives the valuation of my business?”
In this blog series, we’re going to give you a framework for how to think about the valuation of your business. Some of value drivers will be within your control as a business owner and many will not be. Understanding how to think about them can be mission critical to your success - it can factor into your decision making about everything from when to invest in expansion or hiring to when to retire or sell your company. The goal is to help you understand how to create value purposefully – and how to avoid destroying value unnecessarily. We want you to feel like you’re in control of your valuation (to the extent possible), and it’s not just a mystical number that’s pulled out of thin air by a 3rd party.
What do I mean by the “valuation” of a business? For our purposes, it’s not what the business is worth to you – because of the lifestyle it gives you, the company car, the perks, or the cash it generates for you, or the prestige. It’s also not what you think the business could sell for based on something you heard at an industry conference or what someone told you while you played golf at the country club. Too many owners make the mistake of thinking they can sell their business for the same multiple or valuation that someone else got for their business. This is a dangerous assumption that often leads to disappointment when confronted with reality: every business is different and valuations vary significantly, even within the same industry. Don’t fall into the “country club” valuation trap.
There are also technical definitions of “fair market value” that are sometimes used by accountants, financial professionals, the IRS, and valuation experts. These more technical valuations can be calculated using several different complex methodologies. These methodologies include income-based approaches, market-based approaches, and asset-based approaches, which all generally involve analyzing financial statements, conducting market research, assessing comparable transactions, and determining appropriate valuation multiples. Even these more technical approaches to valuation are still very subjective.
Let’s keep it simple: let’s think of value as what someone else will pay for your business right now. And more importantly, if you wanted to get your business ready to sell for the highest possible value in the future – what should you be thinking about? How can you create value for your business – and also avoid pitfalls that destroy your businesses value?
This series of blog posts will try to give you a solid framework you can use.
