Part I
What Business Valuation Means
In this part . . .
Many people think that business valuation is all about getting to a price for a business, and thatâs certainly a big part of it. But we think that valuation is the central concept of what makes a business a business â and that very few people really understand it. In this part, we discuss the reasons valuation happens in a business, and we introduce the accounting concepts in the process. Most importantly, we discuss valuing business ideas.
Chapter 1
The Value of Understanding Business Valuation
In This Chapter
Why the price of a business is only half the story
The importance of planning in valuation
Basic due diligence
Why families are so important in the process
Youâre here for one of two big reasons: You have a business that you want to sell, or you want to buy a business. Very likely, the business in question is a small business (with less than $3 million in annual sales), and it may be the first and only business you ever own.
Before we go further, we want to pay you a compliment. Right now, youâre doing something that painfully few entrepreneurs do: thinking about what a company is actually worth before you make a major decision or take a major action. Youâre already ahead of the game. And because youâre reading this book, you obviously know that business valuation is an important part of that game.
Business Valuation For Dummies is for people who want to understand value. This book can help you get your arms around the many tasks and variables involved in effective valuation of a company and help you decide what kind of help you should enlist to complete a deal. In this chapter, we discuss the importance of valuation, talk about doing research and calculating value, and include some notes on valuation experts and intellectual property. We wrap up with a discussion of passing a family business from one generation to the next.
Basic Tenets and the Importance of Valuation for Businesspeople
Everything has a value. Putting value in dollar terms is the cornerstone not only of running a business but also of investing in almost any form. Knowing how to arrive at a value for the physical and intrinsic characteristics of a business is essential to building wealth of all kinds.
To that end, people who invest in companies need to look beyond the current state of the business they own (or want to own) and consider what decisions they need to make to boost value. People who have experience in those industries are often best equipped to make those decisions, but it often helps to engage a business valuation expert for guidance. In this section, we discuss the concept of value and note some of the main principles of business valuation.
Value differs from price
As the celebrated investor Warren Buffett once said, âPrice is what you pay. Value is what you get.â We would add one more line: âIf you do your homework.â
In business deals, most buyers and sellers have a singular focus on price â and price is hard to avoid. Negotiations ideally produce numbers that both sides can be happy with. But getting to the right price in any deal involves understanding what business assets are truly worth and then structuring a deal around financing and tax realities, which can be quite surprising to those who fail to plan.
Planning drives value
Creating value is a transformative topic in business planning and execution. If youâre creating a product, granted, that product is the focus of the business for customers and your employees. Creating value â long-term growth in asset value in a company youâve built â is something you need to focus on, because a company is the sum of real and tangible assets, investments, ideas, and management talent.
If you can look at all those working parts of a business through the prism of value, the desire to determine and create value in a company can become a much more important driving force in its growth than simple profits and losses.
Proper valuation takes time. People buy and sell businesses for a variety of reasons that arenât all about business. For instance, they may make moves in and out of companies based on career goals. Others devote a lifetime to a business so they can finance their retirement or simply pass the business on to their kids as a legacy. All these motivations drive valuation and should require three to five years to account for ownersâ estate, succession, and exit planning. We talk about the importance of planning throughout this book.
One of the best places to start finding out about the planning process for starting a business is the U.S. Small Business Administrationâs Web site (
www.sba.gov).
No two valuations are exactly alike
No two businesses are exactly alike; neither are the goals and circumstances of business owners. You may be in any of a variety of situations, such as the following:
You may be the child of a company founder, wondering whether you want to take over the company when she retires.
You may be a corporate executive whoâs ready to start a new career with a new business purchased with a cash buyout.
You may be a worried sibling trying to figure out what to do with the family company because the companyâs founder, your father, has died suddenly.
Valuation isnât an exact science for another reason as well: The risk inherent in any business situation is far from static. Depending on the economy and the state of the industry the business operates in, the company may be under tremendous pressure to stay afloat, or it may have great opportunities for growth. Any time the economy goes through a major convulsion, people take a fresh look at what value means and at the realities of any deal. As we write this book, the nation is in the grip of a worldwide credit crisis â an economic slowdown that is redefining the values of a host of assets, from companies to private homes.
All these variables are one reason you wonât emerge from this book with the skills to do a top-to-bottom business valuation. Also, proper business valuation takes a lot of practice. People with finance degrees and long experience in accounting or other numbers-related fields arenât always naturals at valuation, either. Donât worry, though. This book does cover the ins and outs of business valuation and points out the areas in which you can handle valuation on your own â and those for which you should hire some help.
Valuation isnât a one-time deal
If youâre already operating a business to its fullest potential, valuation isnât something you should put off until youâre ready to sell or close your doors. Most tax, business, and personal finance experts say that even if youâre years away from retirement â or years away from your next business idea â keeping your valuation numbers current is a good idea. This way, you can make changes and investments in the business so you can leave the business with the highest valuation possible.
A strategy of continual valuation tells you the following things:
Whether selling your business or merging with another makes sense
Whether you can make enough money from the sale of a business to support your retirement
When you want to set a timetable for your kids or other family members to take over the business
The optimal time to set up an employee stock ownership plan (ESOP) as a way to pull money out of the business in a tax-advantaged way
How often should you run valuation numbers? Frankly, it varies based on need. With computerization, itâs easy for many businesses to program their numbers so they can keep a constant eye on their main value indicators that have been developed for any goal they have on their radar.
If youâre working with a business or tax planner, discuss the creation of a valuation system for your business, whether itâs something you access yourself or have an expert handle ...
