Publications

Business Valuation: Understanding Your Company’s True Worth Before a Sale

Peter Hubert, Partner, MDN Group

Understanding your business’s true value is essential not only for potential sales but also to attract investors or refine your financial strategy. A precise valuation can provide more than a fair price; it serves as leverage in negotiations, ensuring no financial opportunities are missed.

If you’re looking to understand your company’s real worth, whether for a potential sale, attracting investments, or strategic planning, this guide will walk you through strategic business valuation methods. It will also highlight the crucial role of expert advisory services, providing you with the support and guidance you need to achieve accurate, actionable results.

Three key approaches to business valuation

Valuing a business is not a one-size-fits-all process. The chosen valuation method depends significantly on your business type, industry norms, and financial goals. Generally, three principal methods are used, each offering unique insights and challenges.

Earnings-based valuation (DCF)

The earnings-based method focuses on future profitability, which is typically the primary interest of prospective buyers. This approach is particularly well-suited for established companies with stable, predictable cash flows. Common methods include:

▹ Discounted cash flow (DCF): Projects future cash flows and discounts them to their present value, adjusting for the time value of money and business risk.

Market-based valuation (Multiples)

Similar to how real estate agents assess properties, the market-based approach compares your business to similar businesses that have sold recently. This method is highly effective for companies in mature industries with ample market data on comparable transactions.

▹ Earnings multiples: Values the business based on a multiple of its annual profit, often using industry benchmarks.

The strength of this method is its emphasis on the company’s earning potential, which is crucial in negotiations and buyer interest. However, it requires accurate forecasting – a challenging aspect, as unforeseen events can dramatically impact earnings. 

By examining the market values of similar businesses, you gain insights into what your business could realistically sell for. This approach’s strength lies in its alignment with real-market trends. 

Asset-based valuation

The asset-based approach evaluates a business by calculating the total value of its assets minus liabilities. This method considers both tangible assets (e.g., property and equipment) and intangible assets (e.g., intellectual property and patents). The asset-based method is further related to:

▹ Replacement value: Estimates the current cost of replacing those assets.

An asset-based valuation establishes a minimum or “floor” value. However, this method can fall short for companies reliant on intangible assets.

Complications in business valuation

While these methods offer a foundation, business valuation is an intricate process requiring careful analysis and expert judgment. Here are some of the common complexities:

▹ Accuracy in forecasting: When using earnings-based methods, projections depend heavily on industry trends, economic conditions, and operational assumptions. Even minor changes in these assumptions can significantly alter valuation outcomes. Forecasting, particularly for early-stage businesses, is inherently risky and requires a nuanced understanding of market dynamics.

▹ Market volatility: The market-based method can lead to misleading valuations if the market experiences sudden shifts, as seen in economic downturns or industry-specific disruptions. These factors make it challenging to use comparables accurately, which may require adjustments by seasoned professionals who understand market nuances.

▹ Intangible assets: Assigning value to intangible assets like brand reputation, customer relationships, and intellectual property is complex. Unlike physical assets, these are subjective and depend on perceived future benefits, making it difficult to set definitive values.

Due to these challenges, consulting with valuation experts can help avoid costly mistakes. Professionals not only bring technical proficiency but also strategic guidance to tailor valuations based on industry specifics. 

Choosing the right advisory service

Given the complexities involved in calculating business value, partnering with a qualified advisory firm is not just a good idea, it’s a necessity. Professional advisors are skilled in selecting the best approach or combination of approaches tailored to your needs, ensuring your valuation is reliable and effective for your objectives.

To select the right advisory service, consider firms that not only offer technical proficiency but also guide you on strategic steps to maximise your business’s value and ensure its representation in the market aligns with your long-term goals.

Business valuation, with all its nuances, is both an art and a science. Understanding these nuances and selecting the right methods, refining projections, and weighing intangibles can be a daunting task. However, expert advisory firms offer crucial insight, combining objective valuation techniques with strategic acumen to help you navigate this complex process and achieve the best outcomes for your business.

Understanding your business’s true value is not just a matter of potential sales. Whether you’re aiming to attract investors, optimize growth strategies, or prepare for succession, it positions you to make informed decisions and leverage future opportunities effectively.

Here at MDN Group, our team has a wealth of experience in business valuation, working closely with business owners and top management. By understanding our client’s objectives, we tailor our approach to deliver fair business valuation reports.