Unlocking Company Value: A Guide to Valuation Essentials

What is Company Valuation?

A business valuation, also referred to as a company valuation, is the comprehensive assessment undertaken to ascertain the economic worth of a business entity. Throughout the valuation process, all facets of the business are meticulously scrutinized to determine its overall value, as well as the individual worth of its various departments or units.

The exercise of company valuation serves a multitude of purposes, such as determining the equitable value of a business entity for a range of reasons including potential sale, establishing partnership ownership, taxation considerations, and even divorce proceedings. Typically, business owners will seek the expertise of professional business evaluators to provide an unbiased and objective estimation of the business's value.

Reasons For Company Valuation

1. To Seek Investors Or Additional Capital: Different stages of a business require different types of investors. Startups typically need angel investors who base company valuation on the founder's vision and market potential. Early-stage angels often ask for a percentage of the company in exchange for funding, with the option for the founder to buy back equity based on their terms. Mature businesses entering the next stage of funding rely on tangible metrics like profitability, sales reports, and market sizing for company valuation. Investors at this stage look for strong collateral against their investment, particularly if there is little chance of ownership change. Banks and other investors require a review of financial documents to assess company health and valuation, which can be facilitated by a CPA.
2. To Bring In Partners Or To Share Equity : Shareholders need to determine company value through proper valuation methods before deciding on how shares will impact the deal. Consulting experienced professionals in the specific business sector is crucial for accurate valuation. Hiring a larger CPA firm with a dedicated department for this work is recommended. Shareholders should reach agreements to avoid uncomfortable discussions and then negotiate with independent representatives to finalize the deal. This approach ensures a smooth transition into a new partnership focused on collectively growing the company's value.
3. Estimation For A Sale: When selling a company, experts in company valuation are needed, along with audited financial documents. Small companies may benefit from consultants or brokers, while large companies may require investment bankers. These bankers have their own valuation methods and will provide an estimate for the sale. Advisors should consider both investment value and fair market value, which involves multiples on profit and revenue, assets, and other objective figures. The value of the business in an investment context is evaluated based on the buyer's potential gain from the acquisition.

Benefits Of Having A Company Valuation

1. Access To More Investors : When seeking investment for your company after being established for at least a year, potential investors will likely request a comprehensive company valuation report. Whether you are seeking funds for growth or financial stability, a company valuation is crucial for securing the necessary investments. Investors will want to understand the reasons behind your funding request and how they can expect to recoup their investment. The potential return on their investment can only be determined through an accurate assessment of the company's value. Ultimately, investors are focused on how their investment will generate returns and where their funds will be allocated. Having a current company valuation available can attract attention from potential investors who believe that their funds can enhance the company's overall value. Therefore, it is advantageous to maintain an up-to-date company valuation when seeking investment opportunities.
2. Better During Mergers/Acquisitions : When considering selling your company to a corporation, it is crucial to present them with recent company valuation, growth metrics, asset holdings, and market value trends. Knowing your company's true value helps you negotiate fair deals and avoid undervaluation. If offered less than your company's worth, reject the deal or propose a negotiation to reach a mutually beneficial agreement.
3. Get A True Company Value : Understanding the true value of your business goes beyond just financial figures like bank account balances and asset values. Professional valuation is essential for an accurate assessment. Knowing your company's value can guide decisions on selling and pricing, as well as attracting potential investors and buyers.
4. Better Knowledge Of Company Assets : It is essential to accurately determine the value of the business through a thorough valuation process, as relying solely on estimates is not sufficient. Company valuation offers numerous advantages, including aiding in obtaining appropriate business insurance coverage, determining an appropriate selling price for the company, and forecasting the growth trajectory to reach a target value.

Methods of Company Valuation:

1. Market Capitalization : Market capitalization is calculated by multiplying a company's share price by its total number of outstanding shares. For example, Microsoft Inc. was valued at $771.5 billion on March 9, 2019, with a share price of $100 and 7.715 billion shares outstanding.
2. Times Revenue Method : The times revenue business valuation method applies a revenue multiplier based on industry and economic factors. For instance, a tech company may be valued at 4x revenue, while a service firm may be valued at 1.5x revenue. 
3.  Earnings Multiplier : The earnings multiplier is a more accurate measure of a company's value because profits are a better indicator of financial success than sales revenue. It adjusts future profits against cash flow that could be invested at the current interest rate, providing a more realistic valuation based on current P/E ratios and interest rates.
4. Discounted Cash Flow (DCF) Method : The discounted cash flow (DCF) method of business valuation is akin to the earnings multiplier approach. This method relies on forecasts of future cash flows that are adjusted to determine the current market worth of the company. One key distinction between the discounted cash flow method and the profit multiplier method is that it factors in inflation when calculating the present value
5. Book Value : The book value is the difference between a company's total assets and total liabilities on the balance sheet, reflecting shareholders' equity.
6. Liquidation Value : The liquidation value refers to the amount of net cash that a business would receive upon liquidating its assets and settling its liabilities at present.

Conclusion

In essence, conducting a thorough company valuation plays a critical role in helping the organization drive profitability, make well-informed business choices, and facilitate successful transactions in the market.