Business Value Does NOT Equal Price / by Kerri
When you started your business, you were more likely paying attention to the value of your product and services to command a good price. At the same time, you probably were not focusing on what would add value to the business itself.
When it comes time to monetize your business, like when you want to sell off equity or find a buyer; that’s when value becomes a serious criteria in your decision process. That’s because value plays a big part in the price anyone will pay for an ownership position in your company. But as Chris Mellon of Delphi Valuations cautioned when I interviewed him on Exit This Way: “Business value does not equal price”.
Value is commonly discussed as if you’ll execute a cash transaction. But other options such as stock transfers, notes, or earn outs with contingencies, are often involved.
A business appraiser does not know the terms of the deal that will determine the price a buyer will pay for your business. Your valuation expert will look at the overall market assuming a cash transaction to come to a value or rather a range of values. It’s called a continuum of value. For example, a business may be worth somewhere between $7M and $13M and that range will vary for different purposes. Fair Market Value (Fair Value) is somewhere in between.
Why have your business valued?
Maybe you will get a business appraisal for compliance such as in financial reporting or litigation even in shareholder disputes or a divorce; or strategic planning, such as exit planning; or for an acquisition or sale.
Business and personal situations vary. You want to consider the value of your business in your overall decision making process, as a business owner but also in terms of its value in your portfolio.
Then there are also the tax implications for various decisions that can prompt getting a valuation of your business. Three common tax reasons that can drive a valuation are to: assess gift taxes, determine estate taxes, or when you convert a C corporation to an S corporation.
When should you have your business valued?
If you are starting your business on the fast-track to an exit (a targeted acquisition or an IPO), you will want to have a valuation performed early as a benchmark.
Beyond the startup phase, most businesses will benefit from having a valuation performed regularly, even yearly in the 3-5 years leading up to your exit transaction. The valuation exercise will reveal enhancements, improvements, growth, and metrics which will demonstrate a pattern of building business value. In turn that sequence of valuations will give a seller significant leverage in any negotiations in any 3rd party transaction. Businesses put themselves at a disadvantage if they pinch pennies and expect to only go through valuation once, when they are already talking to their prospective buyer.
Building business value goes hand in glove with exit planning to achieve your objectives in the business and beyond. Valuation is an exercise to measure the return on your efforts.