A business valuation is akin to a publicly traded stock in at least one sense. Both, to some extent, are measured by estimated future cash flows in an effort to arrive at a meaningful valuation.
A private business owner, however, doesn’t have the luxury that an investor has of browsing a stock table to appraise worth. Instead, owners must assess the value of their business by providing accurate financial information and identifying risk factors.
Understanding the factors that determine the value of a business can help a business owner focus on ways to increase both short and long-term profits. Carl Pon, co-managing partner of Vicenti, Lloyd & Stutzman LLP, believes that all business owners should know the worth of the companies that they operate.
“It is critically important to understand what the value of the business is so that the owner or owners can determine where they are in the path towards financial independence,” he says.
Smart Business spoke with Pon about some of the primary drivers behind the value of a business, how companies can avoid mistakes when compiling a valuation report and how a business should go about conducting the search for a qualified valuation professional.
Why should a company conduct a business valuation?
The main reason is because the business is probably the largest single asset in the portfolio of a business owner, so it is very important for them to know what that key asset is actually worth. The second reason is because knowing the value is a critical step in helping a business owner develop a strategy for exiting their business and harvesting the wealth that they have accumulated in the business.
How should a business owner go about determining the value of their business?
There are a lot of Web sites out there and software programs that can do the mechanics of a valuation calculation. But my suggestion is that the business owner contact an accredited business valuation specialist to make sure that those tools are being applied properly.
What are some of the main drivers behind the value of a business?
The two main drivers are the expected cash flows that the business can generate and the risk factors at play in the particular business. When you know the cash flows, the timing of the cash flows, and you know the proper rate to capitalize those cash flows at, you know the value of the business.
The theory of it is fairly simple. From a practical standpoint, the drivers of the value can get down into things such as how much depth or breadth is there in the management team and what are the mechanisms in place to keep that management team with that business.
Does a business valuation produce an exact value?
Most reports state a single value, but when you look at the detail of the reports they often present a range of values that are based on different models and different assumptions. In the sense of a specific value, that’s like a best-guess type value. It’s often more meaningful to see what the reasonable range of values would be.
How can a company avoid common errors when compiling a valuation report?
One of the ways to avoid errors is by selecting a qualified professional to help create the report. Above and beyond that, it is critical to make sure that the underlying information and assumptions that are being used are correct. Because with business valuation models the “garbage in, garbage out” metaphor applies. [It is] the one that we use so much for computer systems the end numbers are really no better than the assumptions they are built upon.
How should a business conduct a search for a good valuation professional?
My suggestion would be to talk with your business attorney or banker in terms of who they know. In addition to that, you can consult with the three major accrediting organizations for business valuation experts. Those are the National Association of Certified Valuation Analysts, the American Institute of Certified Public Accountants and the American Society of Appraisers.
How important is it to hire a valuation professional that is independent and objective?
It is critical that the valuation analyst be independent in mind and as well as in appearance. Because part of the valuation analyst’s job is to challenge the assumptions that management or ownership often make when they provide information to the analyst.
Carl Pon is co-managing partner of Vicenti, Lloyd & Stutzman LLP. Reach him at [email protected].