Business valuations – The fundamentals all business owners should know

valuing your business, how to value your businessWhat does a business valuation actually involve?  Do I need one?  Well, if you need to know what your company’s value is, a business valuation is a good place to start.

We’re going to take a closer look at business valuations and specifically the 4 steps to valuing your business.

 

 

Part 1:

  • What are you valuing?
  • Why are you valuing it?

Part 2:

  • When are you valuing it?
  • How are you valuing it?

What are you valuing?

Seems like an easy question, right? Well this is where many business valuations fall at the first hurdle. This is one of the valuation fundamentals and if you get this wrong, the whole valuation will be wrong and that could end up costing you a lot of money.

Business vs company valuation

The most popular area of confusion is business vs company valuation. Most people see these as one and the same but they are in fact very different. A business typically operates within a company and sometimes there can be a number of different businesses operating within the same company.

business valuation, valuing your business, how to value your businessA business has a number of assets and liabilities associated with it that the business needs to continue trading; things such as debtors, stock, plant and machinery, etc.

The company on the other hand, has a number of things, independent of the business, that it needs to operate and this is normally related to the capital structure of the company; things such as debt and shareholder equity and loans.

If someone wants to buy your business, they are not interested in the capital structure of the company, they don’t want to take over your debt, your shareholder loans and your historic tax liabilities.  All they want are the assets they need to continue operating the business and required to generate the cash.

Sometimes though buyers want to buy the company (for various reasons) and in those circumstances they do want the debt and shareholder loans. This could be the case, for example, where the company has some contracts that cannot be transferred to another company and so a buyer has no choice but to buy the company, i.e. the shares.

Value drivers

The other area of confusion is caused by not really understanding what drives value in your business.

Let’s look at a simple case study to demonstrate this:

  • You run a pest control business from a property in central Brisbane that is also owned by the company; and
  • The business needs the property to operate from and you intend to sell the property with the business.

In this case you can’t just value the business using one methodology, such as an earnings based approach (more on that in later posts). You need to value each different aspect of the business. Firstly, you need to value the business on its merits and then value the property separately.  The two valuations are then combined as they are both owned by the same company.

You will probably need to make a few adjustments to your numbers to achieve this. As an example, you will have to impute a market related property rental for the use of the property into your business expenses and then exclude all other property related expenses from your business expenses.

It’s vital to break a business down into its respective parts and then you can determine the best way to value each piece.

Why are you valuing it?

So now you know what you’re valuing it, the next question is why are you valuing it?

This is important as it will determine your approach to the valuation. There could be a number of reasons for valuing a business including:

  • Sale of the business as a going concern
  • Forced sale due to pending bankruptcy
  • Taxation purposes

Your reason for valuing can have a dramatic effect on the valuation result. If you are forced to sell the business due to pending bankruptcy then it is important to be able to sell it quickly. When you do that, you have to expect to apply a discount on some asset values.

So make sure you understand the purpose of your valuation and the impact this will have on the valuation result.

Conclusion

Getting these valuation fundamentals right will set you on the right path for determining your business valuation. If you don’t consider these fundamentals you run the risk of under-estimating the value of your business and potentially selling it for less than you should have, and that’s a direct impact on your back pocket. Alternatively you may not be able to sell it at all because your valuation expectations are too high.

So before you start valuing your business think about the above and be absolutely sure about the what and why of business valuation. Don’t be afraid to seek professional advice if there is any element of doubt.  Do you have any questions on what a business valuation is and why you need one?  Post your questions or comments below.

Join us next week where we’ll take a look at the next two steps of when and how you value your business.

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About latticecapital
We are an independent Corporate Advisory business based in Brisbane, Australia. We established our company in 2008 in response to a gap in the Brisbane advisory market for independent corporate advice. Our principals collectively have in excess of 40 years of Corporate Advisory experience.

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