What’s Your Business Worth?
Whether you’re considering a sale of your business, already evaluating an offer, or simply exploring strategic options, what your business is worth is one of the most important yet challenging questions for a business owner or CEO.
Naturally, a business is ultimately worth its “market value” — the price a buyer is actually willing to pay for it. As CEO, however, you can’t put your company up for sale every time you want to learn what it’s worth.
At the same time, routinely benchmarking the value of your business throughout its lifecycle — regardless of if and when you decide to sell — is critical to measuring your progress against your long-term growth objectives. Neglecting to do so will create a large valuation gap that significantly hurts your chances of success if and when you pursue a partial or complete sale of your business.
So what can CEOs do to better understand what their business is worth?
DISCOUNTED CASH FLOW (DCF) ANALYSIS
A common methodology for calculating a company’s value is the discounted cash flow (DCF) analysis. A DCF analysis estimates the sum of a company’s future cash flows, discounted to reflect their value to a potential investor or buyer today.
The DCF analysis, however, is highly subjective and dependent on the assumptions made in the model. Critical inputs such as the company’s growth rate or the discount rate (an assessment of the company’s riskiness) can significantly impact the results, and are frequently points of contention at a negotiating table.
The DCF valuation, therefore, is usually supplemented by comparable valuation data that can help validate its credibility.
One market-based valuation approach looks at the valuation of comparable companies being traded in the public markets. Trading comparables are a double-edged sword, however: although public company financial data is readily accessible in real-time, the challenge is in finding relevant and truly comparable companies against which to benchmark.
A second method is to look at the valuations of private companies sold in recent M&A transactions. Transaction comparables, too, can present a challenge: private M&A transaction details are opaque, and financial terms are rarely disclosed.
TALK TO THE EXPERTS
It’s possible that you have the expertise and information you need to estimate your company’s value using the approaches above. In our experience, however, most CEOs aren’t adequately equipped.
Even if you think you are — as tempting as it is to think you can go it alone — consider the consequences of getting it wrong. All too often, a business owner’s plan to exit her company are derailed by poorly managed expectations about price.
For 99% of CEOs, you’re better off developing long-term relationships with M&A advisors and investment bankers who can help you understand your valuation and keep you abreast of the external trends that can impact it. Even if you don’t plan to sell the company in the short-term, building a network of trusted advisors is the most effective and least time-consuming way of understanding what your company is worth, short of formally entering the market altogether.
THE BOTTOM LINE
Understanding the value of your business can be mystifying. Your company’s financial performance and market valuation trends are dynamic, and trying to to stay on top of these can feel like shooting a moving target.
As the CEO or owner of a business — regardless of whether you plan to sell in the next few years or keep the business in the family for generations to come — it’s your responsibility to routinely benchmark your valuation and growth. Doing so will require not only that you understand the fundamentals of how investors and buyers value businesses, but also that you find trusted advisors you can turn to for the insights that can help you understand and maximize the value of your business.
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Tags: Axial, DCF, discounted cash flow, exit, Growth, M&A advisors, NationalSponsor, Peter Lehrman, transaction, Vistage International