Valuation of Your Business
A sustainable business also focuses on valuation which is the amount your company will potentially sell for over time. Your valuation is a formula that takes into account your assets, your profitability and your cash flow and that equation results in what your company might be worth in a one, three or five year period to another company.
There are several different reasons why you might want to know the value of your business, including selling it, merging with another business, tax or loan purposes, for estate planning, allocating the purchase price among business assets, establishing an estimate of the value of partners’ ownership interest for buy-sell agreements and more. Whatever the reason, it can be a challenging process to come up with a valid number.
Valuations might also be used to calculate stock options (aka, ‘funny money’). These are not publicly traded stocks, but rather, a metric for developing and managing ownership in the business. Some people want possession of more or less shares, which doesn’t mean much at the early stages of your business; stock options in this case are simply a metric for dividing business based on the principals involved. The only division of stock options should be to people who have invested money in the company (you do not want to give away the company at all, especially to outsiders). There are a lot of ways to do shares and ownership and contribute back, like sharing the success of your business into your employee base. However, early on, giving away shares and ownership in your business isn’t one that’s recommended.
Another developmental metric that will be used in the valuation process is insurance policies. All principals of your business should have what’s known as a Keyman Policy. This is good both for the company and for the families of the principals if someone is unexpectedly killed as a measure of fiscal protection.
There are various types of insurance policies that will be accounted for during the valuation process, such as a general liability policy, accidental death and dismemberment, life insurance on all principals and others. Ideally, your business will pay the premiums on these types of insurances because should they ever be exercised, it is the company that will receive the benefits.
A valuation requires a complete analysis of historical operation of the business itself as well as a study of the projected future for the industry, the economy and the competitive advantage of the company.
To do a thorough valuation is more than adding up numbers from different reports because it takes into consideration intangible factors that are not easily quantifiable. There are more than a dozen different methods of valuation, and the mastery of the professional actually doing the valuation has a tremendous influence on the outcome. In fact, to insure integrity in the number, many valuation professionals use more than one method and compute a weighted average to come up with a final number. The main thing to know is that it’s important to choose both a professional and a method that knows and applies to your industry to get a viable value. And you have to understand the method used so you can defend the end result.
In valuating your business, assets will be considered to see what you have that supports the value of your company. Assets can be a lot of different things including equipment, furniture, electronics, cash in the bank, the customers you have signed up for your program, consistent purchasers or the email list to which you regularly market and sell your company. An asset can also be the copyrights, trademarks and patents that you and/or your company holds; when you exercise to sell your business, the valuation professionals will look at all three of these as adding value to your business (and the more you have, the better).
Regardless of the asset, every asset you have depreciates on an annual basis. Your goal is to refill what depreciates and evaporates in your business to balance this natural shrinkage. This can occur through an existing customer with new opportunities and /or by using their referral network; other times you may need to seek a new customer to replenish that gap.
Historically, studies have shown time and time again that it’s easier to gain revenue from an existing customer than to create from seeking a new customer where you have a proven relationship. Certainly, it’s possible for you to have major wins but primarily ‘organic’ growth through referral strategies will produce more efficiently than cold calling strategies (although this depends on the type of company that you have and your marketing strategy). The big takeaway is that it is vital to create a foundation of strength such that from an external point of view your business would be seen as asset-strong.
Companies and venture capital firms buy or invest in people, patients, predictable revenue and potential, not products nor your pride.
You can have a great product that’s generating income but as soon the due diligence process evaluates the people and the values of your company, the deal could be lost. Toxic cultures taint many acquisitions and funding efforts. Respect and commitment to your employees comes first, your customers are next, everything else, is an extension of those those values that your business represents.
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