By Phil Harwood

The value of your business depends on some important details, which we will discuss in this article. As you will discover, the valuation process is quite subjective. On the other hand, there are two objective statements that we can make with confidence.

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First, owners really care about the value of their business. Valuation matters because it is used in a variety of circumstances. Obviously, valuation comes into play when a business is being sold. But it also may become relevant when changing a partnership agreement, applying for a business loan, or working through a transition from one generation to the next.
 
Second, owners often think their business is worth more than it really is. In many instances, owners are surprised to learn that their business is not valued by the rest of the world as greatly as it is to them. The worst time to have this reality check is when a false assumption has been relied on and there isn’t sufficient time to adjust plans that have been made.
 
So, what is a business owner to do? How are businesses valued in our industry? Where can an owner turn for help? The rest of this article is intended to answer these questions.
 
There are certification programs for those who endeavor to be a valuation expert. If you want to learn about working with a certified valuation expert, I recommend focusing on the different certification programs available. Pay close attention to the minimum requirements of the certification process. Some of these are the ABV by AICPA, ASA by ASA, AVA by NACVA, CBA by IBA, and CVA by AICPA. Full-service accounting and legal firms have these folks on staff. As you explore this option, keep in mind that these people may or may not have experience in our industry.
 
You may be thinking that working with a certified valuation expert will be expensive. It may be, but it’s all relative. If you sell your business for a higher multiple because you equipped yourself with qualified advisors, the cost of an expert valuation will be insignificant and more than worth your investment.
 
At the other extreme is the DIY method, which is not necessarily a bad place to begin. Work your network. Who do you know that has already gone through the process you’re considering (selling, divesting a partner, etc.)? Talk to your peer group members, trade association contacts, and your company’s advisors. This research will provide you with insights into different valuation scenarios, valuation methods, and actual values.
 
At the end of the day, a business, like any other asset, is only worth what someone else is willing to pay for it. A highly motivated buyer may pay a premium because of the opportunities the purchase will afford to integrate the business, expand into a new region, or other strategic reasons. On the other hand, an auction buyer may only be interested in a discount because they are intending to sell off the parts of the business for whatever value can be extracted.
 
Because of the disparity between valuation approaches and scenarios, determining the value of a business is not a simple matter. Furthermore, the factors that go into determining the value of a business may not be constant. For example, the loss of a key member of your leadership team may seriously impact the functioning of the business and its ability to operate smoothly. In this situation, a “turn-key” business that is very attractive to a buyer may lose some value because of the disturbance and uncertainty that losing a key member of the leadership team brings.
 
Valuing a business that is not for sale still requires an analysis of what a hypothetical sale would bring. The steps are still the same. The only difference is that without real-time negotiations to drive up the valuation there may be a slight undervaluation. 
 
Valuation experts use various methodologies for calculating business value. However, the essential ingredients are common to all. The value of real estate, equipment, vehicles, and all other assets is the first component of valuation. The key with this component is to value the assets at a fair market value price, not an auction or fire-sale price, and not an unrealistic overly hopeful price. If you had a reasonable amount of time to sell these assets to an interested buyer, what would the total of these assets be worth?
 
The next component is the value of the business itself, separate from the assets and real estate. The starting point here is with your EBITDA – your “true” profit. The key here is to add back into your EBITDA any expenses you as the owner are taking that a buyer will no longer need to pay for. For example, let’s say that your business pays your boat payment, legitimately. A buyer is probably not going to continue paying your boat payment so you need to add that expense back into your EBITDA calculation.
 
When calculating EBITDA, the other consideration is the trajectory over the past several years. Looking back 3, 5, or 7 years gives more information than only looking at last year or the last two years. Of course, when a business’s EBITDA is growing year over year, the business is more valuable compared to declining or erratic EBITDA results.

The last component is the multiplier to be applied to EBITDA. A multiple of 2 will double your EBITDA. A multiple of 3 will triple your EBITDA. The multiplier is determined by how hot the market is. This is where an expert with particular knowledge of our industry will be helpful.
 
There are other ways to value a business, and different industries have different methods. In some industries, businesses are valued in terms of multiples of revenue. Wouldn’t that be nice! Back in the dotcom days, businesses that never made a profit were selling for ginormous sums. At one time, Amazon was the poster-child of the dotcom era with a flawed business model and no hope of ever making a profit. My point is that valuation can also be somewhat of a guessing game. 

If you’re interested in a free, no-obligation Exiting Your Business Guidebook, email me at Phil@GrowTheBench.com. This is a valuable resource to help you start the process of exiting your business, either through succession or sale. I’m also happy to answer questions about business valuations. 
 
Now go forth.

Note: this blog was first published in Landscape Management magazine.