Determine the Value of Your Business with 5 Essential Questions
Sooner or later, every business owner will exit their business. When an owner begins to consider this, the first question that comes to mind is likely “what is my business worth?” As you plan your exit, your top priorities are to ensure business continuity and maximize value in a transaction; but how do you measure that value? Though this is a complex and multi-layered question, a great starting point is with these five questions:
1. What information can I get from my financials?
There are 3 major pieces of information in your financials that should be examined closely to obtain an idea of business value. The first is your earnings before interest, taxes, depreciation, and amortization (EBITDA). This is a measure of a company’s current operating profitability, or how much profit it makes with its present assets and operations. The second is the seller’s discretionary earnings: the pretax and pre-interest profits before non-cash expenses, the owner’s benefits and personal expenses, and any other non-related income or expenses. The third is your net asset value, or the value of your assets minus the value of your liabilities.
2. How do my company’s historical margins benchmark against other companies in my industry based on industry-specific metrics?
Benchmarking against others in your industry is a very important component for determining business value. At a high level, you will compare your historical margins for the past 3 years to industry peers. It is important to pay close attention to your specific industry benchmarks used for valuation.
The process of benchmarking begins by comparing (common-sizing) items on your income statement as a percentage of sales and comparing items on your balance sheet as a percentage of total assets. Then you would compare those percentages against the averages for companies in your industry with similar revenue ranges.
These metrics vary a great amount from industry to industry, so it is especially important to get a professional, independent, third party valuation by an investment banker or external valuation expert.
3. Are there any characteristics of my business that would detract from its value?
There are a myriad of things that could devalue your business, from how heavily the business depends on you as its leader to the comparable industry performance to customer concentration.
Customer concentration has a meaningful impact on the value of a business. When a single customer or client accounts for 10% or more of your revenue, or when your largest five customers account for 25% or more of your revenue, your customer base/revenue is considered concentrated.
When a business is overly-reliant on a small group of clients, its revenue will be highly sensitive. A 10-25% revenue drop can cause a business to go from being profitable to dropping below break-even and threaten its ability to survive. Therefore, a concentrated customer base increases risk for potential purchasers, who value businesses commensurate with the risk involved in their cash flows.
4. How does my company’s projected performance compare against peers in the industry?
If you are forecasting even better growth and margins than you have had in the past, it’s the quality of the assumptions behind those forecasts that will lend credibility to your business’s future profitability. You want your company’s sales and profit margins to be equal to or above average for your industry, and revenue growth and profitability should be increasing at the same rate or better than the industry average. When you understand your relative financial performance, it becomes easier to explain to a potential buyer where you have an advantage, and as a result have opportunities for growth.
5. How is the industry as a whole performing?
To help determine the value of your business, it’s essential to know where your industry stands as a whole. What is the market sentiment towards your industry? Resources like the Bloomberg Sector & Industry Performance Report can be an excellent tool to provide a general idea of this.
It’s important to set value expectations on the front-end before approaching the marketplace. To understand what your business may be worth in its current state and in the current market you will need to understand how companies are valued in your industry, and how that translates into value for your company. A professional, third party valuation by an investment banker or external valuation expert will help you to set value expectations.