The value of a business is important information for business owners. It enables them to ascertain the worth of a smaller stake in the business so as to sell part of it to equity investors for capital. The accurate estimation of the value of a business is crucial for this strategic decision and a business owner or potential investor could lose money without this vital piece of information.
Beyond selling a stake, the value of a business will help the business owner determine the worth or goodwill of the business in order to know exactly which areas to better invest in. Calculating the value of a business is not a scientific process as there is no single formula for determining the true value of a business. However, there are a few formulas used regularly to estimate the true worth of the business.
Before determining the value of your business
There is a wide range of factors to consider before properly determining the value of a business. The valuation of any business largely depends on a variety of factors such as the age and size of the business, the staff strength, the expected growth as well as a plethora of other factors. You must truly understand each of these elements and how they affect your business before you can accurately value it. For example, know where your business is in the business lifecycle.
While a new business might be valued based on market assumptions of the industry within which it exists, an older business can be valued based on its past results. Furthermore, it is important to determine the best valuation tool to use in valuing your business, and this is also based on the specific characteristics of your business. However, it is pertinent to note that a successful strategy for valuating businesses is to make use of a hybrid of approaches.
Three approaches to evaluate the worth of a business include:
1. Total asset of the business
The asset-based approach seeks to ascertain business valuation by totalling all the assets of the business. In other words, the value of a business depends on the total assets it has. To do this, you have to examine the book value of the business by taking a look at the balance sheet of the business, lists of the total assets of the business, and subtracting its total liabilities. It could also take the form of a liquidation asset-based approach which determines the liquidation value, which is the net cash that would be received if all assets were sold and liabilities were paid off.
2. Comparable Analysis (“Comps”)
Comparable analysis also commonly regarded plainly as equity comps or trading multiples involves determining the value of one company in relation to another one. You simply compare the current value of a business to other similar businesses by assessing their trading multiples. These trading multiples are valuation ratios like the price to equity ratio, or the EBITDA (Earnings Before Interest Tax Depreciation and Amortization) ratio. In other words, it helps you assess what other businesses of the same size and structure (sometimes within the same industry) are worth to determine what your business is worth.
3. Market-Based Precedent Transactions
This is similar to the comps method only that it is based on the sales value of similar businesses to yours. It attempts to establish the value of your business by comparing your company to similar ones that have recently sold or acquired in the same industry. If a company like yours with the same size sold for N10 billion, it means your company’s value is closer to it. The idea is similar to using real estate comps to value a house. The method might, however, not be as accurate and it only works well if there are a sufficient number of similar businesses to compare.
It is a great idea for business owners to have an idea of the value of their businesses. While the tools or formula to help you do this are readily available, it is preferable to seek the services of an investment banker, financial analyst, or business appraiser to achieve an accurate valuation of the business. The first step is, therefore, to hire a professional who will be able to advise you on the best method or combination of methods to use to set the value for your business.