Advanced Concepts On How To Value A Business.
Knowing how to value a business is critical to any owner wishing to sell. Particularly important is knowing about the key drivers that can add to value. Not because you should really consider doing your own valuation. There is value in having a knowledgeable professional do that for you.
The value of a business can depend somewhat on your perspective. Suppose that your business provides you with $250,000 in yearly cash flow. Let's also suppose that you have consulted a directory that discusses value as a multiple of annual cash flow for various industries. From that manual you have determined that the appropriate multiple is 6.
This would firmly fix in your mind that the value of your business is $1.5 million. Now change roles. Look at the situation from a buyers perspective. Consider how to value a business as a buyer. You have examined the same manual and seen the same multiple. But as a buyer are you as quick to believe that this business is worth $1.5 million? You may not be.
Your reluctance to believe it is likely based on the fact that you lack confidence in your ability to replicate the cash flow generated by the current owner. How much of that cash flow is dependent on unusual capabilities of the current owner? Or to his personality or charisma? After all who wants to pay full price for a personality driven business without having an identical personality?
How to value a business, and arrive at a number that most buyers will agree with depends on being able to successfully identify the business drivers that will lead to a successful transition of ownership. You need to identify the needed systems and processes for critical business activities. If you don't have them, you have a choice. Either develop them, or realize that you will likely have to accept a lower valuation without them.
Remember that the implicit assumption underlying the various industry multiples is that performance will continue at its current level, or perhaps improve. If you have implemented proven effective systems and processes recently, you may be able to successfully argue that the multiple for your business should be higher than the industry norm.
Activities related to attracting customers and creating revenue should head your list of proven effective systems and processes. And having more of these is much better than only having one. This will address most buyers' greatest concerns. That they will not be able to equal or better your revenue performance. Multiple methods for attracting customers and creating revenue will give buyers some confidence in the reliability of your valuation.
Each business has its own critical valuation drivers besides customers and revenue. Analyze your own business critically. Determine which activities have the potential to cause you the most trouble. They are also likely to be the most costly when things don't work right. These activities are likely your critical drivers. So if you don't have effective systems for dealing with them, you need to develop and validate them.
Remember that the value of these systems and processes lies in the ability they have to prevent you from reinventing the wheel. When you have determined an effective way of handling a situation, you need to deal with it the same way every time it arises. Not waste time on a creative but unproven solution. A famous author in writing about the US Navy likened it to a system created by a genius to be run by idiots.
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