At some point, you’ll likely need to value your business, determining the market price for your business or company unit. When you get to this point, an accurate valuation is a must; it could determine not only the future of the business, but also your personal profitability in the project.
If your company is publicly traded, some of the work is done for you. Investors determine the price per share through their buying and selling decisions; if you know the price per share and the trading volume (the number of shares in circulation), you can quickly calculate an estimate for the value of your company. However, if you’re trying to calculate the value of a private company, you’ll need to jump through a few extra hoops.
When to Value a Company
There are several conditions that could prompt you to value the company, including:
- Selling the company. If you’re selling the company to an individual or a larger corporation, you’ll both need to determine what’s “fair.” You’ll need to reach an agreement that both parties find adequate for their needs, which can be tricky without an accurate appraisal.
- Adding partners. If you’re adding partners to your venture, you’ll need to know the approximate value of their fractional ownership of the business.
- Accepting buyouts. Similarly, if one of your partners decides to leave and you need to buy them out, you’ll need to know the appropriate amount to provide them in exchange for their share in the business.
- Seeking funding/investments. Company valuations are especially important when seeking new funding. If you’re talking to angel investors, venture capitalists, or if you’re thinking of preparing an initial public offering (IPO), it’s important to understand the true value of your company as it stands today.
In most of these cases, it pays to have a higher company valuation, but your highest priority should be the accuracy of your estimate.
How to Value a Company
Assuming you’ve been prompted to value the company in some way, how can you work up an accurate estimate?
First, understand that it’s a good idea to trust an expert. If you and your partners are inexperienced in company valuations, it’s better to work with a professional appraiser than to try and do it all yourself. At minimum, you should be talking to mentors and other business owners to get their perspectives and polish your initial estimate.
In any case, there are several variables you’ll need to consider, including:
- Your total assets. Obviously, your company’s assets will play a major role in determining the company’s value. If you own a $1 million building, $1.5 million in equipment, and $1 million in other assets, $4.5 million is a good place to start for valuing your company.
- Your past revenue, profits, and losses. You’re also going to look at your company’s past revenue, including you profit and loss statements. You’ll look back at least 5 years (if those records are available), with special attention to figures from the most recent year on record. In many cases, company valuations are based on projected future earnings, and your past is often a good indication of your future.
- P/E ratios for your industry. Most industries have an average price-to-earnings (P/E) ratio, which suggests the “value” of the company based on current earnings. In many cases, you can use this to estimate the value of your own company. For example, if your industry has a P/E ratio of 15 and you project earnings of $300,000 a year, you could estimate the value of your company at $4.5 million.
- Discounted cash flow analysis. Look at your past cash flow and project it into the future. Then, use a “net present value” (NPV) calculation to discount that future value. With these calculations, you can determine the current value of your future earnings.
- Current customers. It’s also a good idea to look at your current lineup of customers and clients. How much of your revenue is attributable to a single client? How big are your clients? How long have they been with you? The more prominent, the more diverse, and the more loyal your customers are, the higher your company will be valued.
- Other variables. Since valuations are based on perceived worth, there are other, more subjective factors you might consider when valuing your company. For example, you might increase the company valuation slightly if you feel your brand has a lot of awareness and recognition.
Putting It All Together
Company valuations are based heavily on mathematical formulas and accounting expertise, but it’s still not a surefire or perfectly consistent approach. Make sure you work with experts during your company valuation process, and don’t hesitate to adjust your figure as you gain more information.
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