Imagine that you just opened your monthly statement for your retirement account, but instead of revealing your current balance, all it said was: “Balance Unknown”. Suppose your financial advisor explained this by saying:
“Most of your net worth is invested in a single stock, and we don’t know how much it’s worth. But don’t worry about that until you’re ready to sell it.”
Would you be worried?
What is My Business Worth?
Many entrepreneurs are in this boat. They spend their lives trying to grow their companies, but few of them track that growth by having their company valued. They think, “Why waste time finding out how much the stock is worth until I’m ready to sell it?” There are several reasons why knowing the value of your stock can lead to better decision making. For instance:
- Buy low, sell high: If a stock price has been climbing, a shareholder may wish to sell some or all of their shares to lock in gains before conditions change. If a stock price has been declining, a shareholder may wish to buy additional stock while it is “on sale”. They might also gift some of their stock to their heirs while the value is low.
- Discover chinks in the armor: A valuation report can reveal weaknesses that decreased the value. Armed with this knowledge, management can address these weaknesses, then track whether their efforts result in higher values. Even if the stock isn’t sold, these changes can make the company more profitable, more consistently.
- Death and taxes: When shareholders die without proper estate planning, there have been cases where the estate had to sell the stock at unfavorable prices under time pressure to pay estate tax. Knowing the value of your stock is critical to establishing an effective plan to pay these taxes and transition ownership in accordance with your wishes.
Business Valuation
While the true value of a business cannot be determined until a price has been agreed upon by a buyer and seller, there are many widely accepted methods of estimating the value of a business. These estimates can consider a variety of buyers. For instance:
- A “financial buyer” would only care about the projected cash flows, and the risk of not receiving them. They would be largely indifferent to which company they buy or industry they enter.
- A “strategic buyer” would have motivations to buy a particular company. The purchase may positively impact the buyer’s existing investments, so they may be willing to pay a premium to ensure the seller chooses them over another buyer.
Because a formal valuation each year may be costly, some companies choose to get a formal valuation every five years and to estimate the value each interim year using simplified estimates or formulas. However they choose to do it, we advise our clients to get an understanding of the value of their company, and to use this knowledge to make better decisions.
You’ve poured your heart and passion into your business. Understanding its worth is a crucial element of entrepreneurship — but knowing what to take into account to garner a true picture of valuation can be daunting. Consider partnering with a business consulting firm to ensure you understand the full scope of your business’s financial picture.