It’s never been easier to access the tools you need to value your company. From fintech platforms to regional merchant banks, it seems as though everywhere you look there is someone offering valuation services. However, just because it’s easily accessible, doesn’t mean that they are all created equal.
Soon, you can become swamped in the information overload of financial metrics. However, while those measures are important and critical, they are not the building blocks of valuation.
In this article, we’ll focus on the four most essential rules of thumb for business valuation.
4 rules of thumb for valuing a business:
- Understand the reason for the valuation
- Is there a change in your firm’s ownership structure?
- Are you evaluating a potential sale?
- Are you contemplating issuing equity to new or existing employees?
Pinpointing the key purpose for pursuing a valuation will help you to better define the scope of services you will require. For example, if your firm has received an acquisition offer, the type of analysis involved will be very different from assessing the value of a potential personal stock investment. The former will necessitate a much more in-depth, and perhaps time-consuming, process than the latter.
2. Understand your business
- Does your business operate in many different geographic areas?
- Do you sell services, physical products, or a combination of both?
- Are you expecting sales to increase significantly in the next 12 months?
Understanding the nuances of how your business operates is critical to deriving an accurate valuation. No one understands your company as well as you. To value your business properly and fairly, you will need to communicate these critical details to your valuation provider. This will help ensure that the resulting estimate is accurate and avoid potential pitfalls with the IRS that may result in nefarious fines that may render running your business impossible.
- Use the right valuation metrics
- Does your company rely on subscription services and run on an asset-light model?
- Do you operate in a high growth market, or one that is relatively stagnant?
- Is your customer base stable, or does your company undergo a high volume of “churn?”
There is no “one size fits all” approach to valuations. For example, if you manage a young software business in a rapidly growing industry, your best bet may be to establish a set of comparable companies and create a valuation based on revenue multiples. If you operate a conglomerate with many diverse lines of businesses, a “sum of the parts” analysis may be most appropriate. Depending on which industry you operate in, the types of products you provide, and how you deliver goods to your customers, methodologies will change.
4. Partner with an expert
Most importantly, it’s critical that you solicit professional expertise to develop a valuation estimate. This will ensure that the valuation you receive is not only accurate, but also compliant with the latest IRS guidelines. By having these rules of thumb in mind before you engage a professional, you will be one step ahead of the process, and ensure that your provider will be receiving business information that is accurate and detailed.
