Business Valuation: Unveiling the Art and Science Behind Determining Company Worth

For most small business owners, their enterprise stands as their most prized possession. However, ascertaining the true worth of their business goes beyond a mere glance at stock prices. The journey to understanding value begins with a meticulous process known as business valuation.

Business valuation serves as a formal procedure aimed at estimating the intrinsic value of a company. This endeavor embodies both art and science, requiring the professional acumen of seasoned analysts who meticulously consider a myriad of factors. These factors encompass the essence of the business, its financial performance, prevailing economic landscapes, asset valuations, liabilities, as well as any distinctive proprietary technologies or know-how. The amalgamation of these elements culminates in a comprehensive estimation of the business’s worth.

What is “Valuation” about?
At its core, valuation revolves around the notion of creating shareholder value, the bedrock of a company’s prosperity. It serves as a guiding light for executives and corporate finance practitioners, illuminating pathways for assessing companies using sophisticated techniques such as the discounted cash flow (DCF) approach. Armed with this knowledge, stakeholders can make informed decisions pertaining to business and investment strategies, encompassing corporate portfolio management, acquisitions, and performance optimization.

Aren’t owners more worried about next quarter’s results than the long term?
Some are, but they shouldn’t be. Research shows that earnings surprises explain less than 2% of share price changes around announcements in publicly traded markets. Expectations of future performance are the main driver of stock prices. In almost all industry sectors, up to 80% of the stock market value is attributable to expectations about cash flows beyond the next 3 years.

What should owners worry about instead?
Sometimes, managers have to make trade-offs between short-term earnings and long-term value creation. Investments they make today may come at the expense of next year’s earnings, but also may be crucial to producing earnings in later quarters. DCF approaches help provide the right answer when making such trade offs. In addition, performance in the short-term is a legitimate predictor of long-term performance. Getting the balance right is the key to maximizing value creation.

What factors are important when it comes to valuation and creating value?
An array of factors influences the valuation process, each bearing its unique imprint on the company’s worth. Location, competitors, managerial depth, operational efficacy, and market conditions stand among the myriad of considerations. Delving deeper, qualitative assessments through management interviews and site visits enrich the valuation process, imbuing it with experiential insights that complement numerical analyses. Several factors can influence the valuation of a business, including:

•  Earnings and revenue
•  Assets and liabilities
•  Market conditions and competitors
•  Growth potential
•  Brand value and reputation
•  Nature of business and history of the business
•  Economical benefits of the business
•  Effectiveness of the management and its strategies
•  Location
•  Concentration
•  Staff and management

What are the trending transaction multiples for business value in the current economic market (Companies with enterprise values of $10 million to $500 million)?
2023 went out with a sigh as a hoped-for end-of-year rebound in middle-market deal flow never materialized. Even as average deal price improved in many of GF Data’s size tiers throughout the third and fourth quarters, deal activity fell to a low not seen since 2017, with just 57 deals completed by GF Data’s contributors in the fourth quarter.

However, valuations on completed deals in the fourth quarter averaged 7.5x Trailing Twelve Months (TTM) adjusted EBITDA—an increase of 0.2x from the third quarter and well above the 6.7x average from the second quarter. Average multiples for the year slipped to 7.3x compared to an average of 7.6x for both 2022 and 2021.

How does my company compare to average valuation multiples?
No two companies are exactly alike, and there may be factors that affect their value that are not captured by the valuation multiples. One of the most common correlations between company sales and higher multiples is size, both in terms of revenue and EBITDA. For example, a company often warrants higher multiples once they hit certain size metrics such as $10 million in EBITDA or $100 million in revenue. Additionally, your company may have a higher or lower growth rate, profitability, risk, or competitive advantage than the comparables. To account for these differences, you may need to apply a premium or discount to your valuation estimates based on your qualitative and quantitative analysis. However, it is not an exact science, and it requires careful selection, application, and adjustment of the valuation multiples and the comparables.

Why do I need a company valuation?
A company valuation can be essential for various reasons. It provides insights into a company’s financial health, growth prospects, and overall worth. Here are some key reasons why a valuation is necessary:

•  Investment Decisions: Investors, whether venture capitalists, private equity firms, or individual shareholders, need to assess a company’s value before investing. A valuation helps them determine if the investment aligns with their risk appetite and expected returns.
• Mergers and Acquisitions (M&A): In M&A transactions, both buyers and sellers rely on valuations. Buyers want to ensure they pay a fair price, while sellers want to maximize their sale price. Valuations guide negotiations and facilitate informed decisions.
• Financial Reporting: Companies must report their assets, liabilities, and equity accurately. Valuations help determine the fair value of assets (such as real estate, intellectual property, or inventory) for financial statements.
• Tax Compliance: Valuations impact tax calculations. For instance, property tax assessments, estate taxes, and transfer pricing all require accurate valuations.
• Employee Stock Options: Valuations determine the value of employee stock options. Employees receive options as part of their compensation, and knowing their worth is crucial.
•  Litigation and Disputes: Valuations play a role in legal proceedings, such as divorce settlements, shareholder disputes, or bankruptcy cases. Courts rely on expert opinions to assess damages or allocate assets.
• Strategic Planning: Company leaders use valuations to make strategic decisions. Whether expanding, diversifying, or restructuring, understanding the company’s value guides these choices.
• Financial Modeling: Valuations serve as inputs for financial models. Projections, budgeting, and scenario analysis rely on accurate company values.
  Remember that different valuation methods exist (e.g., discounted cash flow, comparable company analysis, asset-based valuation), and the choice depends on the context and purpose of the valuation. Ultimately, a well-executed valuation provides clarity and informs critical business decisions.

What advice do you have for companies preparing for a professional valuation?
For companies embarking on the journey of professional valuation, a few guiding principles prove invaluable. Foremost among these is the imperative of maintaining meticulous records and adhering to regulatory standards. Additionally, the development of forward-looking projections offers invaluable insights into the company’s future trajectory, serving as the cornerstone of many valuation methodologies. By heeding these principles and embracing the intricacies of the valuation process, companies can unlock the latent potential of their enterprise, guiding strategic decisions that pave the path to sustained prosperity.