Every business owner needs an exit strategy in order to realise the capital value built over the years. A business is not just a source for an income stream, but an asset with an underlying value. Many reasons could compel you to think of exit planning.
After enduring so much over the years, your business becomes more than just a job. As such, it is natural that you are concerned about what will become of it once you move on. This care and concern will help determine what type of exit strategy will suit best. In addition to that, you want to ensure that you get the most value out of your business. This article explores the question ‘what is value in business’ to help you leave on your terms and maximise your wealth as much as you can in the process.
What is value in business?
Value in business refers to the net asset value of a business. Net asset value is the difference between total business assets and total liabilities.
The tricky part is determining what to include as assets or liabilities. Furthermore, when determining the value of each item you have to factor in the prevailing market conditions. Additionally, the intangibles of a business influence the net asset value.
The asset-based approach is suitable for incorporated businesses since they are separate entities from the owners. Using the asset-based approach in a sole proprietorship is difficult, as separating personal and business assets is complicated.
Earning potential valuation
This approach considers a business’s potential to produce revenue in the future. There are two main types of earning potential valuation:
• Capitalising past earnings: This method entails finding the net present value of expected future profits and dividing by the capitalisation rate. A capitalisation rate is the expected rate of return from a business that is normalised to reflect the present market conditions. Capitalising past earnings considers the current cash flow and the annual rate of return to predict future earnings.
• Discounted future earnings: This method forecasts the business’s future earnings then normalises them to the current market conditions using the capitalisation rate.
Earning potential valuation is suitable for a business looking to merge with another or buy it.
Market comparison valuation
This approach determines the value of your business by comparing it to similar ones that have sold recently. The downside of this method is if similar businesses sell for less than their worth, you’ll sell yours at a loss. Unfavourable market conditions can force such a low price on those businesses, which, in turn, affects yours.
These four valuation approaches suit different situations and businesses. For a fair valuation, use all of them to reveal more information and balance the market forces.
What steps cover the valuation process?
1. Planning for the valuation
The first step involves determining why you need the business valuation. While valuation is supposed to be an objective process, the purpose influences the process and results. For example, the business asset values are different when you need to merge with another company compared to when you’re selling your business.
Next, you have to collect all the necessary information for the process. This involves collecting the business financial statements, marketing, business plans, staff records, etc.
2. Adjusting the business financial statements
Valuation is not just an economy-focused exercise that comes down to analysing the business’s financials. There is a qualitative assessment to identify how sustainable, predictable and performing the business will be post-exit without the owner(s). The dependency on yourself, the owner, needs to be addressed long before the exit date, and the business autonomy led by a performing management team needs to be well proven. You’ll need, of course, the income statements and balance sheets for the past five years. Expect to normalise those statements and their reports since it is common for businesses to report less than the true business potential due to tax reasons. In addition, a business owner has sole control over the use of assets. The aim here is to paint an objective picture of how business assets were used to produce revenue.
3. Selecting the preferred business valuation approaches
Once you have all the data you need, you can pick which valuation method to apply. As mentioned, it is wise to use a combination of all methods to get a clear and detailed analysis of the business value. However, some reasons for conducting the valuation call for one or two methods.
4. Applying the chosen approaches
Once you settle on the preferred methods, it’ll be time to apply the data in step two. It would be best if you ended up with reasonable and justifiable figures. Using different approaches also helps compare the results to pick a fair yet favourable figure.
5. Concluding the process
Since different approaches will yield different results, it’s best to reconcile them with a note on your decision to do so. For example, you could rank the approaches in terms of how well they apply to the reason for seeking valuation.
Determining the value of your business is a critical first step to any significant change. Whether you’re formulating an exit strategy, wealth creation plan, or a retirement plan, you need to get this process right.
At Biramis, we have more than a century of value creation and value building experience. We focus on the value-building process to suit your exit strategy. In order to maintain integrity, we ask independent valuers to carry out the valuation. When you commit to us as your exit planning partner, you can be confident you’ll get the best value for your business, take care of your employees, suppliers, clients, providers of finance, and ensure its continued success. Book a free business clinic with us today, and let us help you take care of your treasured business and turn it into a valuable asset.