Understanding Business Valuation & Finding the Right Buyer
For growth-minded business owners, a valuation is one of the most important financial tools available as it will help you understand what someone might be willing to pay for your business.
Here’s a look at the basics behind a business valuation and the different types of buyers out there for your business.
Calculating a Valuation, Made Easy
A business valuation formula is the starting point of your valuation journey. While there are many ways to approach this formula, the most elementary approach to valuing a business is to subtract its liabilities from its assets. This method is commonly referred to as an asset method, but it’s rarely that simple. The same goes for trying to base an entire valuation on revenue.
You can take different approaches to how you calculate the market value of the business, basing it off Normalized EBITDA or DCF (discounted cash flow). Normalized EBITDA focuses on adding back seller’s discretionary expenses to EBITDA. Normalized EBITDA is based on income, whereas DCF looks at current cash flow and projected future income based on that cash flow.
Approaching your valuation formula using Normalized EBITDA as our starting point will add back some expenses to the business earnings total. Common add-backs are expenses that have some degree of personal benefit to the owner.
The formula itself looks like this:
(EBITDA) + (Interest, Taxes, Depreciation & Amortization) + (such as travel, vehicles, and other transactions that are listed as business expenses) = Normalized EBITDA
Unlike Normalized EBITDA, DCF scrutinizes the cash flow of a business. The valuation attempts to determine the current value of an investment based on expected ROI (return on investment) in upcoming years. The approach takes a few steps and is best calculated with a valuation professional, like a CPA or a business valuation firm.
Other factors that may influence the valuation of your business may include hard assets (equipment or real estate) versus soft assets (customer lists and vendor relationships), marketing, cash flow stability, debt, and projected sales.
Meet the Buyers
Of course, the value of your business doesn’t exist in a vacuum. Its value reflects how much someone will pay for it.
That said, the value of your business may skew depending on the different types of buyers out there. Here is a quick look at the most common types.
These types will offer a price based solely on the financial avenues of the business being purchased. They don’t bring synergies or operational efficiencies by buying your company and simply want to pay what the business is worth. There is a range of payout agreements that can be made with a financial buyer.
This type is experienced in their industry and intends to acquire a business to either absorb it or turn it into a cash generator for their own company. A strategic buyer will often pay a higher amount for the initial sale but will rarely want the current business owners involved in ongoing operations. They’re also a rarer type of buyer but, if your company is the right fit, they will find you.
Private Equity Buyers
This type is usually a financial institution that has the intention of buying your business so they can grow it as a part of their portfolio to be sold again at a later date.
As rarest of buyers, this type is simply looking to buy a business for personal reasons. Whether they seek a visa in a foreign country or simply want to own their next best business, their reasons are personal.
What Is Your Business Worth?
No matter where you are in your journey, it’s always important to keep your key differentiator in mind and keep capitalizing on it. The more insights you can get into your business and its value, the more profitable it can be not only for a future buyer but for every day between now and the day you’re ready to sell.
Yes, we are biased but who better to evaluate your business than your trusted accounting partner, who knows you, your business, your industry, and what your numbers mean?
For more information valuing your business, speak to one of our valuation experts today.