Thursday, September 20, 2018

Understanding valuation: How much is your business worth?

by Monica Talender (writer), , October 02, 2015

Credit: CC Public Domain
CC Public Domain

Placing a value on a business can be a nightmare for many CEOs. What to start with, what to base the valuation on? How can the estimation be accurate?

And when it happens to be your own business, the struggle can become even greater. But today it’s a crucial step for any business to take. Here are some tips any CEO should keep in mind before speaking to a valuation expert.

There isn’t only one “right way” to value a business. There are several and if conducted properly, they can all be successful. As Mohandas Pai, chairman at Manipal Global Education said, “valuation is an art, not a science.” There are, however, wrong ways that could prevent a valuation from benefiting the company. This process needs to be well understood in order to be efficient.

Today, there are many specialists offering valuation services who have explored the best valuation methods and know how to adapt them to each and every situation. But this shouldn’t prevent the business owner from understanding exactly what he is getting his business into.

One way to evaluate your business’s worth is to look at its assets. Account for everything you own and everything that makes your business possible. From each and every piece of equipment you have purchased to the location of your headquarters is valuable to you. This is when keeping good records comes in handy, something every business owner should be doing anyway! In looking at your files, you should be able to determine most of these assets that you have already. Without that, this could become a challenge and a long inventory process.

But you still have to keep in mind which of these assets make your business valuable and which may be a burden. “It is critical that you eliminate any unnecessary or extraneous expenses that reduce the profits from your company, and thereby reduce its value” wrote David S. Burton, President of The Appraisal Foundation (1) “For instance, putting personal possessions on the balance sheet, such as a vehicle that is not essential to the operation of the business, will raise the overall asking price of the company, and decrease its desirability to purchasers who only wish to acquire the business operations” he added.

You then have to look at your business liabilities and subtract it from your assets in order to get a raw idea of your net worth. That is where it can become tricky, according to valuation and corporate finance expert Aswath Damodaran, who believes that is where “most of the companies experience issues that can sink a business valuation”, that’s what he calls “the Bermuda triangle of valuation” (2)

But when it comes to a more financial assessment, then the valuation can become even trickier. As Yann Magnan, Head of European valuation practice at Duff & Phelps observed, “Valuation has always been technical and tricky. But valuation only reflects the world’s complexity since it becomes more and more financial by nature. There are more financial issues and frequent crisis today. That generates uncertainty and our clients have to deal with it every day. Hence their need to call on experts with very robust, up-to-date experience in valuation.” (3) Duff & Phelps has specialized in valuation for a wide array of clients for almost a century now, including emblematic leaders in their industries, and has become the largest provider of valuation services in the world to such a point that Duff & Phelps assess almost every tangible and intangible asset or existing financial instrument.

Performing the assessment of intangible assets requires an extended knowledge in intellectual property, brands, names, technologies or even software development. That’s how Duff & Phelps has built a reputation with a valuation practice in every asset class. Their advisors and consultants developed an expertise in the different branches of business in order to bring insight advice to their clients “…advisors at Duff & Phelps permanently scrutinize the evolution of standards and they concretely take part in reflections about it. As our company has become a privileged interlocutor over time, we generally play a significant part in standards reinforcement,” says Yann Magnan.

That is most likely the main problem in today’s valuation world and what you may encounter as a business owner in need for valuation services: the lack of norms and standards to improve the credibility of valuations. Having more of them would improve the capacity for more homogeneous valuations in the differing fields of business and globally.

Sir David Tweedie, former chairman of the International Accounting Standards Board (IASB) and now Chairman of the Board of Trustees of the International Valuation Standards Council (IVSC), is now working on implementing the regulatory system. According to Tweedie, ‘There’s a lacuna in the regulatory system: you have prudential regulators, which are saying, “This is what you have to do”; you have the accounts, so people can judge the markets. But in the middle is the bit that affects both of them, and that’s valuation.’ (4) Sir David Tweedie has been bringing lessons learned as chairman of the IASB for about 10 years to the IVSC. ‘If we aren’t valuing financial instruments accurately, you have spurious profit-and-loss accounts and balance sheets. And anecdotally there are big differences. You’re never going to get everyone within three decimal places, but what we need to do is get that range narrowed to within the bounds of acceptability, because the evidence I’ve seen indicates that some of this could move net worth by 3%. Some banks’ equity isn’t much more than that!’ he said.

So, as a business owner looking for valuation services, but scared of the lack of standards, that may change really soon. The IVSC has recently signed a memorandum of understanding with the International Federation of Accountants (IFAC) in order to set international standards for auditors and accurate valuations in order to “make the right call on a company’s accounts.” And making the right call is exactly what you should expect for your own business’ development.

One of the other valuation formulas developed is based on a business’s revenue. Today many business are still being valued by multiplying their revenue. But once again, it creates confusion as the multiplying factor is not the same for each business and one number off can create extremely different values.

Finally, one method has been to go into earnings instead of just revenue. It is always possible to have a high annual revenue without necessarily turning it into a profit. The approach of looking at the earnings is therefore more adapted. However, once again, looking at the intangibles is essential and complex.

Going to an expert for valuation needs has become essential, but it just as essential for companies and their CEOs to really understand the valuation process, because they are the key to a complete and accurate valuation of their firms, which is the best way to make them even more profitable and successful.

(1) How to maximize the value of your small business, David S. Bunton, Huffington Post, July 30th 2015

(2) “Bermuda triangle of valuation: these three issues can sink a business valuation”, Aswath Damodaran, Forbes, August 16th 2015.

(3) “How Duff & Phelps became a leader in valuation services, an Interview with Yann Magnan, Head of European valuation practice at Duff& Phelps”, Daily Management Review, August 24th 2015

(4) Interview: Sir David Tweedie, Lesley Bolton, AccaGlobal, March 2nd 2015

About the Writer

Monica Talender is a writer for BrooWaha. For more information, visit the writer's website.
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