The transition of a business is, without a doubt, potentially the most significant financial event for the owner. Therefore, knowing the value of the business - and, perhaps more importantly, understanding factors that may increase or diminish value - is essential for those entrepreneurs who are exploring a sale or other transition and seek to maximize the final proceeds.
Many owners of middle-market companies - both small and large - believe that they know their company's market value. All too frequently, an owner's concept of market value is not credible because it is based only on estimates or formulas, combined with common misconceptions. Every business owner who is serious about ultimately maximizing the value of his or her business should consider the following:
The purpose of knowing value
While a valuation is crucial to any successful sale or transition process, knowing the value of a business - at any given time - can be important to ownership for many other personal and business reasons. It is a powerful benchmarking tool that serves to constantly measure ownership's objectives in regard to an eventual, and inevitable, exit or other transition. An accurate valuation also provides benefits related to banking, insurance, stock option grants, intergenerational transfers, and instances of unexpected major events such as death, partnership dissolutions, etc. An understanding of the key elements of business value also provides the owner with the knowledge and insight to operate the business with an emphasis on its profitability while, simultaneously, focusing on maintaining or increasing its value.
The elements of value
More often than not, the most important and unique factors that add to the value of a company are found beneath the surface. These are facets of the business that, generally, the owner may overlook, ignore, or not even recognize. Valuation and mergers-and-acquisitions professionals, on the other hand, focus on uncovering these otherwise "hidden" elements of value and this, in fact, can assist in determining the appropriate valuation methodology applied to a particular enterprise. Properly analyzed and effectively positioned, value can be more about how the business is likely to perform in the future than how it, in fact, has performed in the past. From the perspective of a potential acquirer or investor, these unique factors are likely to generate interest in the marketplace, further enhancing the company's ultimate value.
The factors that change value
Value is dynamic. External factors such as the economy, the mergers-and-acquisitions marketplace, stock market volatility, investor confidence, interest rates, geopolitical considerations, industry trends and competition present cycles of constant change that impact value. Internal conditions, of course, also change - often in combination with external factors, sometimes independent of those factors. Changes do, and will, occur and they always tend to impact business value - sometimes eroding value and sometimes increasing value. Consequently, they can negatively impact the transition plans of business owners or, on the other hand, offer unexpected opportunities to those who keep a steady focus on the value of their companies, who understand how to interpret both internal and external changes and ... who are prepared to act.
The inconsistency of value
Assumed consistency applied to any valuation methodology is almost certain to produce inaccurate results. For example, an assumption that all businesses in a given industry should trade at similar price/earnings multiples could certainly result in an incorrect conclusion that, in turn, would produce an inaccurate valuation. Experience shows that it is possible to see more variation in multiples among companies in the same industry than among companies in different industries.
Whether the intention of a business owner is to sell all or part of his or her company now, restructure or implement growth strategies to enhance value for a future sale, or explore various other forms of transition, a thorough valuation assessment is a powerful tool that will serve as a solid foundation for making intelligent, informed decisions. It will assist in identifying potential options and measuring these against the personal, business and financial objectives of ownership. Most importantly, it will allow the owner to be proactive in determining, developing and implementing strategies to achieve the most successful outcome. Clearly, knowing the fair market value of a business places the owner in control.