(NNPA)—Business valuation is critical to raising venture capital seed money but it also plays an integral role in planning estate taxes and selling a business. Finding the value of a small business or home-based enterprise is more difficult than calculating the clear value in the number of shares for a public corporation listed on a stock exchange.
When calculating the value of a small business you should take into account elements such as assets, liabilities, profitability, customer base, goodwill, sales revenues and proprietary operations management workflow techniques. Particularly, a small business valuation is predicated on finding an acceptable figure that suits both parties expectation. In the case of estate planning, the vehicle or enterprise structure i.e. TRUST, S-corporations, nonprofits and sole proprietorships will have tax implications that should be considered years in advance of the event.
Consulting a tax attorney, accountant or financial planner is best in assisting entrepreneurs to arrive at the optimal value of the business. This serves as useful supporting materials to establish the basis in achieving a reasonable fair market value for the enterprise. By using knowledgeable advisers it provides a second opinion solidifying your findings.
Calculating the value of a business is not an exact science. Many times it is difficult to place a single set figure that reflects the true worth of the business. Initially, the hard numbers such as assets, liabilities, historical earnings and cash flow are relatively straightforward. However, more subjective figures including projected revenues, niche skills and knowledge, quality operations management or proprietary manufacturing techniques, significant customer relationships are harder to place a single value on. Other factors impact the business value, for example, current market conditions and industrial competitive advantages such as popular brand names.
Industry sector comparisons of a business against other similar enterprises or product brand names may also be a valuable tool in achieving the optimal price tag for selling a business. Financial comparisons should use measurable benchmarks such as sales growth, gross margins, earnings before taxes as a percentage of sales, return on assets and debt-to-net- worth ratios.
The final valuation placed on a business is heavily dependent on three methods used to perform the calculations including valuing a business net assets, multiple earnings and standard formulas.
Primarily, calculating the business net assets is most easily derived from the financial balance sheet. This figure is straightforward and often attractive to buyers that may be unwilling to pay much more than net asset value. However, it is not a good figure for reflecting intangible assets such as popular brand names, future sales growth and goodwill. Specific items like computers, manufacturing equipment and buildings may be vary widely in value from what is reflected on the balance sheet. Other elements including replacement value should be negotiated into the value.
Another important factor involves calculating the earnings multiple or price per earnings ratio (P/E ratio). The price per earnings ratio reflects the true net profit after tax liability of the business. Generally, it defines how much investors are willing to pay to buy the shares of the business. When selling a business or calculating the value, it is acceptable to apply a discount of 35 percent but if your profit is less than $1 million it is more likely about 50 percent due to the small size of the venture that indicate unpredictable revenue fluctuations.
Business valuations in some cases may rely on established standard industry sector formulas. For example, the value of a local courier service is based upon the average daily delivery volumes or insurance firms where agents may multiply their gross commission by one to two times to reflect the worth of the business. Consulting entrepreneur mentors, financial advisers and other knowledgeable business sources is prudent to finding an acceptable formula specific to calculating the ventures market worth.
Once arriving at the optimal value for the business, it provides a basis for capturing seed money, external investors, estate planning and selling the enterprise. Other terms such as “sweat equity” that incorporates the hard work, niche skills, and proprietary operating methods should play into the resulting financial equation.
Particularly in stagnate economic markets, don’t expect prospective buyers or venture capital investors to be rational in their offers. It is acceptable to add 5 to 10 percent on top of the set business valuation figure to compensate for negotiating the terms of agreement. Always approach a situation from a strong position, armed with superior knowledge but realistic in expectations.
(Farrah Gray is the author of “The Truth Shall Make You Rich: The New Road Map to Radical Prosperity, Get Real, Get Rich: Conquer the 7 Lies Blocking You from Success” and the “Reallionaire: Nine Steps to Becoming Rich from the Inside Out.” He is chairman of the Farrah Gray Foundation. He can be reached via e-mail at firstname.lastname@example.org or his website at http://www.drfarrahgray.com/.)