That’s one I get a lot in my field of business valuation:
“What is my business worth?”
“Give me a rough idea – back of the envelope.”
And as an old mentor of mine known as ‘Dr. Value’ would say: “It Depends.”
Most people don’t wake up one morning and think: “I wonder what my business is really worth?”
Ok, some do. But then they usually lose that enthusiasm at the notion that they might need to spend a few bucks to get the answer.
The reality is that a valuation is typically performed because someone else will tell you that you need to have a valuation performed. It’s usually in order for you to complete some other task – the real objective – if you will.
Here are just some of the reasons that might trigger the need for a business valuation:
Objective #1: You’re trying to incentivize your key employees with stock-based compensation.
- Your accountant advises that you need to have something called a 409A valuation done…and you thought that they were talking about cleaning your kitchen.
Objective #2: You’re trying to gift shares of your business to your children or grandchildren.
- Your attorney advises you that you need a valuation to satisfy the requirements of the IRS.
Objective #3: You’re trying to raise capital either through private equity or a public offering.
- You’re told by both your accountant and your attorney that you need to have those stock options valued. (No, they’re not ganging up on you!)
How to Value The Business
There are several methods used to value a business, but at a high level, there are two key fundamental ways to think about the value of your business:
- The value of your business is equal to the present value of the future monetary benefits it can deliver. (Income-Based Approach)
- The value of your business is equal to what someone else is willing to pay for it. (Market-Based Approach)
These are the underpinnings of the Income and Market Approaches to valuation.
Naturally, the only way to know for certain what someone is willing to pay for the business is to put it on the market, but knowing how similar businesses transact will get you in the ballpark.
Why It ‘Depends’
The value of your business (or business interest) depends on what exactly needs to be valued, why it needs to be valued, when it needs to be valued and for whom it needs to be valued.
A few things to consider:
1. Is there debt on the balance sheet? If the answer is ‘yes,’ the value of your business depends on how much. As an every day example, if your house could be sold for $300,000 today but you have a mortgage (debt) of $200,000, your equity interest is only worth $100,000. The same is true for the business.
2. Is your valuation as of a recent date or do you need to go back in time to say, the date of someone’s passing for an estate matter? Markets and valuations change over time.
3. If your needs pertain to a minority ownership interest in the business, understand that it will generally be worth less than a controlling interest in the business.
4. The value of the minority interest also depends on what other classes of equity have preference ahead of it.
5. Furthermore, if that ownership interest is illiquid, understand that it will be worth less than if it were traded on an exchange or otherwise lacked the restrictions on liquidity.
** Bonus Tip For Business Owners **
Have you been running the business with a strategic goal of trying to minimize your tax payments? If so, that means that your financial statements probably show that you aren’t really all that profitable.
Saying it that way has a different feel about it, especially from a potential buyer’s perspective, doesn’t it?
NOT. REALLY. PROFITABLE.
And what value might a not-really-profitable business have?
Five times zero is still zero.
If a sale or other liquidity event might be on the horizon, you probably should discuss this point with your advisers fairly soon.
So if you do wake up one morning wondering “what is my business worth?,” remember that “It Depends.”