If you are a business owner considering selling your business, what is the first question you would ask yourself? Is your answer: what is my business worth? If so, that is a natural response. Most business owners considering a transition have worked on building their company for many years, potentially taking home a significant salary, or receiving dividend payments. To decide whether to sell, you will need to weigh your financial options, which understandably depends on the value of the business.
Step 1: Financial Statements
Regardless of whether you use an accounting firm to prepare your financial statements each year, your first step should be to collect statements going back 3 to 5 years. Internal statements can be used but it may require more effort on your part to position the financials in such a way that is suitable for valuation. By considering multiple years of statements, the resulting valuation will be a more accurate picture of the business’ operating capabilities overall and minimizes the chance that the final value is disproportionately affected by one really good or really bad year.
Step 2: Normalization
Business owners have the opportunity to use their discretion in determining which expenses are paid for by the company. It is extremely common to see personal expenses, such as a company vehicle or a yearly golf membership for the owner tracked on the books. To get an accurate valuation of the company, a process called ‘normalization’ must occur to remove any non-standard expenses. According to the Corporate Finance Institute, financial statement normalization involves adjusting non-recurring expenses or revenues in financial statements or metrics so that they only reflect the usual transactions of a company.
Step 3: Industry Research
A common phrase in M&A is that “a business’s value is determined by the market’s appetite,” which essentially means that the business is worth only what the market is willing to pay for it. Performing industry research and monitoring similar deals to your industry or size, will provide you with context for what buyers are willing to offer. A combination of industry research and financial analysis of the business will produce a multiple for which the company is expected to be able to sell at. EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization) multiplied against your multiple is the most common method to calculate an approximate value of the corporation.
Step 4: Valuation
A valuation will be slightly different every single time it is performed, even if the valuators use the same methods and have the same input information and education. Valuations are a mix of art and science; it is just as important to tell a story with the numbers as it is to calculate a justifiable multiple. The choice between valuation methods is primarily determined by the type of business and general financial performance.
We generally use three main approaches for a business valuation:
1. Asset Approach
2. Income/Cash Flow Approach
3. Market Approach
The asset approach considers the value of all property, equipment, and physical assets required for the business to function. The income/cash flow approach formulates a value by analyzing the company as a going-concern, this is generally a function of the business’ ability to continue to earn income and return on investment (ROI). The market approach values the equity of a company based on observations of public and private transactions. We then use a variety of weighted average calculations to remediate any differences between the business values under the different methods to conclude with one number that the team feels the business could reasonably sell for.
Tip for Success: Choosing the Right Valuator (Accountant vs. Valuation Analyst)
1. Verify Experience – how often does this firm or individual perform valuations for the purpose of selling a company?
2. Understand Your Timeline – your valuator will be your guide through the sale process… can they keep up with your timeline to sell?
3. Target Market – business valuations depend on industry… has your valuator worked with enough types of businesses to have the breadth of knowledge required?
Additional Reading
Corporate Finance Institute. (2022, December 22). Normalization.
https://corporatefinanceinstitute.com/resources/accounting/financial-statement-normalization/
