The BizFilings blog covering business tips and trends.
Valuing a Business to Get the Most from Investors
Published on Sep 5, 2012
Read our article, 'Valuing a Business to Get the Most from Investors' at 'Time to Start Up,' the small business blog by BizFilings.
It's a difficult question to answer, but sooner or later every business owner must sit down and figure it out: How much is my company worth?
Most small- and mid-sized businesses can carry on for years before having to properly value themselves, but for enterprises that are constantly expanding and looking for new sources of capital, it's something that will likely come up sooner rather than later. Knowing the real value of your company can be a serious advantage when dealing with investors, and could keep you from giving away too much during negotiation.
If you know how much your company is worth in real terms - not the broad-stroke guesses of "three times annual sales" or "six times earnings" - you set the stage for investor contracts. If you aren't aware of the value of your company, this not only conveys an aura of business naivete, but you open yourself up to being steamrolled during negotiation. In that scenario, an investor can take the lead and potentially wrangle a large percentage for a low price.
There are a few ways to value your company as accurately as possible. However, most of the major valuation methods - explained below - do not provide a complete picture of businesses' value, so it takes a tailored approach to properly value your company, given its business model and industry.
Asset valuations: Simply tally the cost of the business' assets. This can include buildings and equipment, inventory, even office furniture and stationery supplies. Also include a value for intellectual properties, such as copyrights and patents. Don't forget employees - they may be your greatest asset of all. For many small businesses, however - especially those that are light on assets - this may not be the most appropriate valuation method.
Cash flow valuations: This is the closest method to the "three times annual sales" rule of thumb, and can be a little tricky. The rule suggests businesses should evaluate their yearly revenue and multiply it by a factor of two, three or four depending on a variety of factors. Revenue does not necessarily mean profits, though. A company could have $500,000 in annual sales but still not turn a profit.
Liquidation valuations: This method provides an assessment of the value of a company based on what it would raise if it sold of its assets in a short period of time. As with the asset valuation model, everything from office chairs to bulldozers could be included in this assessment, depending on the business. Intellectual property, however, cannot be included in a liquidation valuation.
Obviously, these are very simple explanations of processes that can be very complex. It's highly recommended to engage professionals when valuing your company, but it can still be helpful to enter the process with some knowledge of how a valuation might proceed.