Unicorns are magical, mystical animals, and when you're a business entrepreneur, you want your company to have some of that magic. While entrepreneurs may feel their company has value, understanding how to accurately assess a company's valuation is important for business owners, entrepreneurs, employees and investors alike.
While not every company can be a unicorn with a value of over $1 billion, each group will have different reasons for wanting to know the value of the company. Big or small—understanding your company's proper valuation is one of the keys to goal-setting that can help you make your own business magic.
What is business valuation, and why do you need one?
As a business owner, you may have an idea of what your company is worth. However, a business valuation is the formal process used to estimate that specific value. "Estimate" is an accurate word here because business valuation is part science and part subjective opinion based on expertise. It relies on the professional judgement of analysts who look at a number of areas, such as the nature of the business, value of its assets, cost of liabilities, financial performance and local, regional and national economic conditions.
Business valuation will hold significant importance depending on one's stake in the company:
- Business owners and entrepreneurs. They will use this value to borrow money, sell a part of the business to help fund growth or court investors to help raise investment capital to help fuel growth. It can also help determine if they should take the company public.
- Investors. The value of a company could be relevant for those considering making an investment in the company. It is also helpful for on-boarding a new partner or shareholder so their shares are correctly valued.
- Employees. Those who receive stock or stock options as part of their compensation package may also be interested in a company's value.
There are several other reasons why you, your investors and your employees can benefit from knowing the value of your company:
- Financial planning with a focus on retirement and succession planning. This is important when it comes time to put the company up for sale or prepare it for future inheritance. Part of this process could include the gifting of shares to your designated heirs.
- For tax and personal reasons. This would include things like determining estate taxes or determining a divorce settlement.
- Professional disruptions. The most common examples of this are dissolution of a board, removal of shareholders, bankruptcy and lawsuits.
- The establishment or updating of an employee stock ownership plan.
How to know your company's worth
In order to arrive at the most objective figure, consider hiring a consultant to take on this task. An analyst who specializes in determining a business valuation will take various internal and external factors into consideration. They include:
- Company size
- Management team
- Vertical market and industry performance
- Company operating experience
- Stage of growth
- Revenue and profitability growth
- Market sentiment
- Comparable company performance
- Industry performance
- Overall economic factors
- Impact of technology
These factors all carry weight during the evaluation process but could be weighted differently depending on what's most important in each company's situation:
- Company size. Usually the bigger the company is in revenue and industry performance, the higher the valuation.
- Profit. A company that's showing a profit or has a higher profit margin is often valued higher than those in the same industry with lower margins.
- Growth rate and market traction. Your company's market share and growth rate are key factors when valuing a company. The larger the market share compared to your competitors, the higher your valuation could be.
- Competitive advantage. What makes your company special? What sets it apart from other companies in your industry? Your products, services and/or solutions need to not only provide value to your customers but do it in a way that differentiates you from other companies.
- The sustainability of that competitive advantage. Having a competitive advantage is good but it needs to be sustainable over an extended period of time to help your company maintain get ahead over others.
- Potential for future growth. If your industry is expected to grow, or your business is planning an expansion of its product, business or service, it may get a higher evaluation.
Benefits of getting a business valuation
We've talked about the what, why and how business owners can get a business valuation, but let's look at the various benefits of business valuation.
- Getting a true company valuation and knowledge of company assets. Even if you do nothing with your company's valuation in the short term, knowing the true value of your company gives you the knowledge and power to accurately plan next steps, whether it's succession planning, selling or raising capital. Part of the evaluation gives a specific value to your company assets as well. This may be useful for insurance purposes.
- Knowing the resale value of your company. If or when you decide to sell your company, it's necessary to know its true value. This can help you during negotiations to get a fair price. It may also give you the time to improve your company's value before you put it up for sale.
- Better negotiations during mergers and acquisitions. Similar to a sale, if you're looking to merge with, acquire or be acquired by a company, knowing the value can help you can negotiate the best deal possible based on numbers provided by your analysts.
- Potential access to more investors and capital. Investors want to see the books when they're considering providing capital. The better your company's valuation, you may better your chances of getting an investor's interest and access to more capital.
Knowledge is negotiating power. Spending the money on a professional to provide an evaluation of your company could be a good way to help your company's future. When it comes to succeeding in business—and boosting your company's value—it's all about effectively Planning for Growth.
This article is intended for general informational purposes only and does not constitute legal advice or an opinion on any issue. It should not be regarded as comprehensive or a substitute for professional advice.