What Factors Contribute to a Company Valuation?
Before selling a company, buying a business, or investing in an entity, you need to know what it’s worth. While this sounds obvious, countless entrepreneurs jump into transactions without full awareness of the underlying value of the business.
They may sell to an equity investor because the price sounds good. They may retire and let their partners buy them out at a price that seems fair. Or they may jump on a stock purchase or acquisition because it looks like a good deal. But all without a professional valuation, many of these deals leave money on the table.
You cannot underestimate the importance of professional valuation services. Before moving forward with any merger and acquisition activity, you need to understand business valuation factors and how to increase the value of your company. Check out these 12 factors that contribute to a company’s value.
1. Financial Performance
The financial performance of a company is a core part of its value. Generally, business valuations start with a number tied to financial performance such as earnings before interest tax depreciation and amortization (EBITDA). Then, they multiply that number by an industry-standard multiplier.
Subpar financials can significantly degrade your value. Depending on the markets, if you’re selling, you may want to wait and work with an interim CFO to improve your performance. If you’re buying, on the other hand, you may want to jump on a company that has sub-optimal financial performance based on mismanagement.
2. Market Conditions
In addition to considering internal factors, you have to look at the market conditions. The markets shape the multipliers, and if you don’t understand the markets, you may end up grossly under or over-valuing a company. That’s why it’s critical to work with an M&A specialist who has experience in your industry and an in-depth understanding of market conditions.
3. Assets and Liabilities
The assets and liabilities on your balance sheet can be even more important than the bottom line on your profit and loss statement. Prospective buyers and investors will look closely at these numbers when doing their due diligence, and you need to make sure they’re reflected accurately. This may require adjusting the carrying value of assets that have changed in value.
4. Risk Assessment
Valuation specialists look at both internal and external risks, and they assess how these risks may degrade the value of your business over time. This includes everything from shifts in management teams to changes in consumer tastes and countless points in between. Overlooking acquisition risks can often expose investors to higher than necessary risks.
5. Economic Factors
An accurate business valuation also takes into account micro and macro-economic factors. Analysts must consider how a particular business fits into the changing global economy. They must consider how projected changes in interest rates will affect this company. This ensures that the valuation takes into account the business’s historical performance while also considering how economic shifts are likely to affect performance and cash flows.
6. Market Share
The more of the market you command, the higher your value is likely to be. However, you cannot just consider general market share. For example, if a business dominates the market in an area that an acquirer wants to reach, that increases the business’s value for that buyer. Because of that, value can often vary depending on whether or not you’re dealing with a strategic buyer.
7. Intellectual Property
Many business owners overlook the value of their intellectual property, but their acquirers don’t. Even if it’s not currently recorded on the balance sheet, a company’s intellectual property can drive its success, and it needs to be accounted for in its value.
8. Discounted Cash Flow Analysis
Discounted cash flow analysis essentially helps investors consider the effect of inflation on their investments. It looks at the present value of expected cash flow, using a discounted rate. This allows investors to assess the value of their initial investment in terms of anticipated future cash flow.
9. Management & Team
Your team isn’t on your balance sheet, but they are the backbone of your company. Consider what would happen if you lost all of your staff and managers — how would that affect the value of your company and its ability to operate? Analysts take human capital into account when assessing the value of a company.
10. Market Comparable Analysis
When determining the value of anything, you have to consider what similar items cost. This applies to everything from widgets to houses to businesses. However, the lack of comps can make it very hard to evaluate a business.
That’s why it’s critical to work with someone who understands the mergers and acquisitions space. They deal with assessing business values every day, and they understand the interplay of dynamic business valuation factors.
11. Legal and Regulatory Environment
An accurate business valuation also takes into account the legal and regulatory environment that affects the business. The valuation needs to consider the business’s current regulatory and legal environment, but even more importantly, it needs to consider how changes to these elements are likely to improve or degrade the value of the business.
For existence, looming legislation that would increase competition may reduce the value of a business, while pending legislation that indirectly reduces regulatory costs may boost its value.
12. Exit Strategy and Market Demand
Value is always tied to demand, and when considering business valuation factors, you also have to consider the owner’s exit strategy. For example, with a buy-out deal, the owner takes a check and walks away from the business. But with many other types of arrangements, the owner stays in place and must meet additional objectives to drive up the total value of the deal.
At DHJJ, we provide a range of advisory services including both personal and business advisory. If you’re thinking about buying or selling part or all of a business, you should lean on business valuation services to ensure you get the best deal possible. Regardless of which side of the table you’re on, we can help. To learn more, contact us at DHJJ today.
