Maximizing Business Valuation: A Short Guide
3 Levers for Maximizing the Value of Your Business
We value the things we love. In fact, we often overvalue them. The significance of things that mean something to us is far more in our eyes than in anyone else's. When we look at it from a business perspective, this can be a disadvantageous way to look at things. If you are an entrepreneur or a small business owner, only you know how much effort and money you have poured into your venture.
While putting in the effort is absolutely essential, it often taints your perception of the company. You will find that a lot of business owners and entrepreneurs overestimate the worth of their companies or businesses. While business valuation is mainly done by using a lot of underlying statistics, there are still ways to achieve maximum value when selling the business.
In order to truly judge the value of a company, you will have to remove any bias. Looking at the business or enterprise from a neutral perspective is a better assessment of its worth. A case study involved when a 65-year-old doctor who asked to get a valuation on his practice. The doctor wanted to retire early due to health complications. As expected, the doctor valued his business to be worth around 1 million dollars, whereas our evaluators put the value to around less than a hundred thousand dollars. So why was there such a drastic difference in valuation? And why was it nearly ten times less than what the business owner had thought?
The right valuation
It all depends on how you see your small business and looking at the right factors when valuing your business. It is your duty as an entrepreneur or a small business owner to maximize your company's value. To do this, you must first look at factors that define the valuation of your business:
What is the maximum amount of money anyone will pay for your business, irrespective of their understanding of the market, the customers, or the goods and service you are selling? The maximum they are willing to pay is the face value of your company.
Evaluating your business with respect to a similar business. When you directly compare your business with another, you will see the differences. If the competitor has already undergone a valuation, it will be a good benchmark for your business.
Check the net present value or NPV of future cash flows. This is very important in determining the scale and scope of the business. You want to see what the value of future cash flow is in today's market. If the return is positive, it means your business will grow.
Understanding the value of your company
Business owners need to know that there will always be a difference in the company's perceived valuation and the actual value of the company. Another point to note is that the valuation is not a particular sum or amount but rather a range. As a business owner, you want your business to be valued as close to the upper end of that range, and it all starts with maximizing the value of your business.
It should be your absolute priority to make your company as valuable as possible. Keeping this in mind, you should try to incorporate adding value to strategy, decision-making, and the business itself. Every action you take is responsible for adding value to your business. This may include new product innovations, creating intellectual property, purchasing hard assets such as real estate and equipment, for example. If you keep this in mind while starting, your decision-making will be impeccable. You will eventually have a business that is valued highly and sought after by many investors.
Getting to a good business valuation
These days a lot of small businesses start without the fundamentals. They simply get into the market to make money. If you wish to create a valuable business, there are three areas you need to look at. If you dedicate your focus to these key areas, you will have a business that is not only solid today but will hold promise in the future.
Growth: The first thing you need to look at is how far will my business grow? Once you have an answer, you will need to look at virtually every branch of your business. The areas of a business where you need to look at from a growth perspective are sales, margins, assets, capital, industry, size of the market, product or service, employees, capacity, and lastly, profit. If you notice trends in the aforementioned areas and follow them with growth in mind, you will have a successful business.
Profit and cash flow should be your focus, not revenue. The latter is not a clear indicator of growth. By prioritizing cash flow, you will see that your NPV shoots up. There are two important reasons why you should focus on this area. The valuation of a business is based on the projected ROI. Hence, profits should be the focus, not revenue. b. Income needs to be shown clearly on financial statements for tax returns. Having this transparency helps increase the value of your business. c. Mitigating risk is an essential hallmark of a good company. It shows that you are studying the market and avoiding mistakes.
Risk: The metrics by which you can judge good risk aversion are:
Consistent sales, continuous revenue, and a diverse group of customers.
Being a competitive and valuable company in the market.
Implementing processes that bring about results.
Building your brand, trust, and making key relationships with stakeholders.
The ability to run independently of any assistance.
Now that we know what the factors are, let us look back at our case study. The doctor was the only practitioner, and his business was on a decline as he was the only one working. This brings about very important factors in business--significant risk, low profitability, and negative growth. The business only had few things of value, namely, the equipment, lease, and his patient list. Although for the latter, the patients have to stay on once the doctor leaves, which is not guaranteed. Its value was over a hundred thousand dollars initially, but as he had to stay on and work part-time, the value dipped.
This case study shows us that the business valuation can be significantly increased if we focus on three areas: Risk aversion, Growth, and Profitability. John Warrillow's bestseller Built to Sell: Creating a Business That Can Thrive Without You is an excellent guide to help you bring about these changes in a small business.
