A crucial question in preparing a business for succession or sale involves the price. Valuing a public company is relatively simple. You can use the current market price of the stock. With a private company you do not have that luxury. You must determine value through specific company analysis.
Typically, that process involves two parties: an independent third party evaluator and an accountant. Establishing a realistic yet competitive value for your business is critical. However, some business owners accept the best market offer for their business, and skip the evaluation.This approach is not recommended.
Obtaining a professional evaluation is fundamental to negotiating an optimal price. And that in turn can impact the development of credible financial and retirement plans after the sale has been concluded.
Value is Subjective
Value is subjective and it’s important to ensure that a proper and professional valuation is conducted. The Canada Revenue Agency (CRA) reviews business transactions carefully to ensure that neither of the parties involved receive an unfair tax advantage.
There are three principal criteria deployed in valuing a business:
1. Asset Value
A company will have assets such as equipment and buildings. It will usually have liabilities as well such as loans outstanding. The asset-based approach to value implies that a company is worth its assets minus its liabilities.
Or, if it is a service business, it may have intellectual property value embedded into it, or the value attached to any and all proprietary processes it has developed and owns.
2. Earnings or Cash Flow
This valuation assumes that a company is worth the present value of an ongoing anticipated stream of earnings or cash flow. Cash flow criteria are more commonly used. They are clearer compared to earnings techniques.
The calculations required to determine value are complex. They require a steady hand. It is advisable to retain the assistance of qualified professionals.
3. Personal Goodwill
Personal goodwill is value that attaches directly to an individual or group managing the company rather than the company itself. It is, in most instances, an intangible asset that is notoriously hard to value.
In circumstances where an owner offers exceptional skills unavailable elsewhere, that person’s continued involvement in the company can enhance the value – and therefore price – of a company, and be reflected through a management contract/earn-out.
Challenges & Opportunities
What follows is a checklist of just a few of the things that you should consider:
- Should your business be evaluated professionally?
- Your business may be both asset and service rich. Do you need assistance to make that determination and put a value on it?
- Establishing Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) is a delicate, time-consuming task. Is there an expert to help you analyze approximations of sectors and average selling prices relative to your own?
Conclusion & Next Steps
The earlier you engage a qualified team to guide the process, the better positioned you’ll be to navigate complexities, uncover opportunities, and make informed decisions that support your long-term goals.