It might be the toughest question a business owner will need to answer: How much is my company worth? The answer depends on a myriad of factors, including what’s happening in the industry, the broader economy and internally.
Whatever the circumstances, routinely going through a business valuation can be tremendously helpful. Sometimes the reasons stem from internal triggers, such as a potential sale, new partnerships, estate and tax planning, fundraising or debt refinancing. Other times, they come from external factors, such as divorce or corporate litigation.
Even when it’s business as usual, it’s beneficial to routinely take an unbiased look at the value of a closely-held business, if only to make better strategic decisions.
But not all business valuations are created equal. There are three main approaches to assign a value to a company. In most cases, no single method is sufficient on its own. In fact, the best reflection of a company's worth may require looking at it from many different angles.
To get started, business owners should be prepared to produce the following documents: the past three years of profit and loss statements and balance sheets; a list of all major assets; details of significant creditors, tax liability, leases, loans, extraordinary employee contingencies and other liabilities.
Consider the following methods to perform a comprehensive valuation of your business.
Discounted Cash Flow Analysis
Forecasting future cash flows is a way to accurately assess a company's ability to generate revenue in the future. This valuation method looks into the financial future of the operations and predicts what the business is worth today based on assumptions of its expected cash flow in the future.
A discounted cash flow analysis weighs the expected rate of return to arrive at a discount rate and, subsequently, the present value of expected cash flow.
While discounted cash flow provides a good snapshot of a company’s internal financial picture, its blindspot is external factors. For example, industries and sectors, especially now, are more susceptible to the velocity of disruption from technology advances.
Comparable Companies Model
The model of comparable companies, also referred to as “peer group analysis” or “equity comps,” looks to the outside for similar businesses and relevant merger and buyout valuations.
This analysis puts companies in a matrix of multiples of earnings against their peers. These comparisons are most common among publicly-traded companies, but privately-held businesses can still look to public markets to arrive at a valuation.
A common “comp” compares multiples of earnings, such earnings before interest, taxes, debt and amortization, or EBITDA. This multiple brings focus to the business operations and strips away non-operational impacts on earnings.
For small private companies in industries with no publicly-traded comps, this process will be more of a general guide that is supported by other valuation methods. The benefits are that EBITDA is easy to calculate and, when taken in comparison with peers, provides a real-time snapshot.
A more blunt model focuses on a multiple of revenue, which is often used to calculate the ceiling price of a company. This takes a period of revenue (i.e. trailing 12 months) and compares recent and comparable business sales as a multiple of revenues. Because some businesses or business lines may generate a lot of revenue but little profit, this model can overstate a company’s value.
Finally, precedent transactions are a matrix of comparing the recent sales in a relevant peer group—and can be indicative of broader trends in the industry. Usually, this takes the form of a spreadsheet that lists comparable recent sales of companies and their relative valuations such as enterprise value to sales, enterprise value to EBITDA, or enterprise value to EBIT.
This valuation is most accurate in an industry with many recent acquisitions for comparison. It can shed light on the take-over premium a buyer made over its target company’s earnings or revenues. The shortcoming of this model is volume. When the last comp in this group comes from three years prior, this form of valuation loses its currency.
To be sure, no single valuation method is likely to offer a clear view of a company’s worth. To get the most accurate picture, owners will want to look at valuation through many different lenses.
It takes time to get an accurate read on a business, but the exercise can reveal areas of weakness and opportunities, and ultimately inform better decisions. What’s more, companies that make valuation a regular exercise will find that it gets easier—and potentially more accurate—each time around.