What Is Business Valuation?
Business valuation is essential when a company wants to sell a portion or all of the business, merge with another company, or acquire another. It is a process of determining all aspects of the business, from its current worth to projected growth, revenue, debt, and other crucial areas, by applying objective measures. Usually, an investor or a potential buyer evaluates the company’s value by looking at its business valuation outcome.
Why is it important?
A proper valuation is crucial to ensure the company is headed in the right direction. It can also help mitigate the risk of underselling a business. It gives a detailed overview of the business’s health and sustainability in the long run. Choosing the suitable valuation method is vital as each entity has a unique business model, which will help precisely interpret the business value.
The valuation methods
A valuation usually includes the company’s capital structure and a thorough analysis of the management. Future earnings prospects and the current value of its assets are of course also of interest. The method used in valuation could vary among analysts, evaluators, industries, and even the size of a company. The primary or common approach is to firstly review the financial statements. This is often done by using the discounted cash flow method, or making a similar business comparison. Below are six standard forms of business valuation which widely used across industries:
- Market Capitalization: This method is the most straightforward and fastest. It derives by multiplying the company’s per-share price by the outstanding number of shares. The result will show the current market cap size of the company. Most of the time, this number is compared with previous years to analyze how much the company has grown in its value. It might give a rough projection of future growth potential.
- Times Revenue: Under times revenue, a series of revenue that you generate over a certain period is applied to the associated industry multiplier. This will also depend on the current economic situation. The industry multiplier plays a significant role in determining the value of the business within the same industry.
- Earnings Multiplier: This method will create better value for a company than the time’s revenue model. It is because the profits your company earns are more reliable as it is based on the financial success of the company. A company that decides to acquire another entity usually prefers to use this method because it closely reflects the financial soundness of the business.
Other commonly used valuation methods
- Discounted Cash Flows: DCF use projected cash flows in the future, which you need to adjust to calculate the company’s present value. The current inflation rate is an important factor when using this valuation option. Usually, a company presently low on cash flows but expecting more business activities in the future might benefit from this method.
- Book Value This is one of the quickest techniques to evaluate a company. It is done by simply subtracting the total liabilities from the total assets. You can find these numbers on the balance sheet of a company.
- Liquidation Value This means how much a company is worth if it liquidates its business and pays off its current liabilities. Getting a positive net asset value is favorable, especially if the company wishes to sell the business in its entirety.
Pro tip: Read about What is an IPO? – Startup Tandem
How could a startup company benefit from having one in place? And what is the best valuation method?
A startup entity is almost always low in cash flows and probably has little to no revenue during the initial stage of the business. So, if a startup wishes to sell its business or participate in M&A, it has to show a reasonable business valuation to attract investors and partnerships. Out of the six methods above, I think the best way to evaluate the company is by using DCF. This model creates fictitious future cash flow values based on the business projection, which is done using the basis of current plans and patterns of operations. A comparison with a similar company will give a better picture of the company’s growth and sustainability in the future. Analyzing the expected future cash flows will provide a clearer picture of the company’s present value.
Having a valuation in place will also help the business owner navigate the business better while considering the factors leading to its value
How can a startup increase its valuation?
When you create a valuation by using any of the methods best suits the nature of the business, it is more likely to effectively address the areas of a financial statement that need to boost. Identifying these elements will hugely impact the business processes. It can also enable the company to run efficiently for better valuation in the future. Some of the common ways a company could increase its value are as follows:
- To have a thorough and defensive growth plan: A business especially in the early stage will benefit from creating a vigorous and defensive growth plan for the next couple of years or more. You can do this by stating monthly projected growth and support with facts and figures. Usually, this information will pique investors’ interest and help the business move in the desired direction.
- Build a robust management team: For the sustainability of a company. A new entity must form a strong management team who can drive the company’s profitability and activities while holding on to the principal foundations of the company. This will add value and create a positive perception of the outlook of the overall management
Other important aspects of a valuation
- Lead sources and revenue diversification A company should diversify its revenue and business lead sources to stay competitive. It should also create barriers for competitors to take over the market. You can do this by having multiple market segments targeted. The business lead resources rather than heavily relying on a single avenue. Product and service diversification could open doors to a broader network of trade.
- Create patents on intellectual properties This is common for a company with unique and distinctive products or services. Patenting the brand, image, or technology will reward the company in the long run and automatically increase its valuation. Investing in the upkeep and advancement of these intellectual properties will benefit the company and enable it to grow with the market progression. For example, Apple’s technology is unique and stands distinctive amongst its competitors, thus making them strong and nearly impossible to copy due to its patented properties.
Pro Tip: Read more about choosing the best exit strategy for your business – Startup Tandem
To better understand the value of a business, choosing a suitable valuation model is essential. A company can have one in place to reference and compare with previous performance. The underlying information should be precise and thorough to achieve the best result, especially from the financial statement. Potential investors will first want to know the company’s worth and projected growth before deciding on investing or acquiring it. Besides that, it also helps when filing business taxes, as the IRS requires a company to show its current fair-to-market value.
How can Startup Tandem Advisory help?
Here at Startup Tandem Advisory, we will be able to assist you in advising and choosing the right way to perform a valuation. Firstly, we will study the industry and create appropriate benchmarks to compare a company with its competitors. Our advisory process includes research, analysis, and recommendations for what needs to be done and how. Secondly, we will be able to identify the areas to improve the financial statement. We will gather enough information to execute a business valuation accordingly. If you want to, we will provide ongoing advisory services on growing and sustaining the current business operation. This can help create higher sustainability, especially during market uncertainty like we are experiencing now. If you are remote contact us for a free consultation, if you are in California, contact us to make an appointment to one of our LA locations!