Knowing the value of a business is smart and strategic. Commonly, a business valuation is for those wanting to: buy, sell or exit; measure business growth; restructure; pass the business to family; settle property relationship issues or resolve shareholder or commercial disputes. A valuation also helps business owners make informed strategic decisions and better understand the value drivers within their business.
There are several approaches for working out business value. A valuation expert can determine which approach to use. Three common methods include – Market Approach, Income Method (capitalisation of earnings, discounted cashflow, brokered database of sales information) and the Asset Accumulation Method.
In general we can say value reflects all future cashflow that can be extracted – or that value represents risk, growth (opportunity), and cashflow. To establish value we need to consider what stage the business is at in its lifecycle. Each stage will have its own characteristics, issues, and value.
In establishing value, we consider the financial results of the business and look at areas such as sales and marketing capability, operational excellence, people capability, systems and processes and the quality of the supply chain.
The valuation will also include an assessment of risks and ways the business mitigates exposure to those risks. The assessment will include a review of contractual arrangements, external environment influences (e.g. industry outlook and issues and technological advancements) and internal environment influences (size, quality of earnings, debt, customer base, reliance on key personnel, and systems and processes).
Documentation is key
If you are going into business with someone else it pays to think about issues that could affect the relationship before you enter into any agreement. The documentation you have to mitigate risk is a vital part of your business value.
Before relationships break down, ensure you have robust documentation in place, such as shareholder agreements and company constitutions, or a binding agreement on shareholder exit provisions.
Make your business more valuable
Not only is a valuation a great tool to help identify the current value of your business, but it also highlights areas for improvement. To increase value you want to increase profit and reduce risk. Increasing profit can include identifying and executing growth opportunities, building and leveraging networks, and looking for areas where investment will increase profit.
To help reduce risk consider reducing your reliance on just one or two key people, monitor compliance obligations, identify future threats and make sure your contractual agreements are solid.