March 6, 2017
What do Business Leaders Need to Know About Strategic Valuations?
Although most business valuation firms prepare numerous reports for tax, accounting, and other regulatory purposes, they also often offer services to companies wanting to know the value of their business for a variety of strategic, planning, and negotiation purposes. Knowing the value of a business can benefit management in a number of ways, and receiving a third party valuation report can allow business owners to make educated decisions that are backed by unbiased, data-driven information. Valuation firms generally have access to data sources to which most companies do not have access.
How Can a Company Benefit from a Strategic Valuation?
Because strategic valuations are not required by a regulating entity, many business owners find it unnecessary to receive a private valuation of their company; nevertheless, any business (big or small) can greatly benefit from a third-party valuation. The following are two simple examples of situations where a valuation could be of use to management:
1. Considering an equity transaction in the business: Whether management is looking to raise capital or incentivize employees with ownership of the company, it’s important to first have a good understanding of what the business is worth. Understanding a business’ worth will be crucial in the negotiation process of any equity transaction.
2. M&A and IPO Planning: It can be extremely helpful for a company preparing for an eventual exit through sale or IPO to understand current market conditions and the valuation that the company would likely receive upon exit. Properly understanding industry multiples and company trends can not only help in the negotiation process with potential buyers, but can also help management to optimize the timing of either a sale or IPO.
3. Future Retirement and Wealth Transfer Planning: It may be possible that a business exit itself is a business owner’s retirement plan, as is often true with many small businesses. When this is the case, an accurate valuation can be an important tool used to make key decisions that could affect quality of life in retirement as well as the ability to transfer wealth to future generations. Knowing how much the business is worth currently can help management to decide how much of the company to gift and when. Additionally, a clear understanding of value drivers is analogous to the due diligence a potential buyer would perform. Identifying these value drivers can better ensure that a company’s owners make it to a hoped for eventual ownership transition.
The benefits that come from receiving a valuation are not limited to these examples, as many situations may arise that call for a professional valuation.
Why Hire a Valuation Firm to Perform the Valuation?
It can often be important to find a third-party valuation firm that has no vested interest in the decisions following the valuation rather than the company itself performing the valuation or even an investment banker or business broker who would be incentivized to push business owners toward a transaction to help generate a fee. Bankers and business brokers can be valuable resources, but they are notorious for inflating value expectation on the front end to push a business owner into a sale process and then making excuses on the backend when the inflated values aren’t realized but the business owner feels too far down the path to stop a transaction.
A competent valuation firm is also very important if the analysis will drive transactions that will be subject to IRS or other regulatory scrutiny down the road. For example, if management is using a strategic valuation to develop a retirement and wealth transfer strategy, it’s important to keep in mind that for tax purposes an additional valuation in the future will need to be performed under IRS guidelines when an actual gift or transfer takes place. Management will need to have a view today on company value that will use the correct valuation standards, or else today’s strategic valuation may result in the wrong tax planning advice.
What to Know When Choosing a Valuation Firm?
A strategic business valuation will help management to make important decisions, so it’s helpful to hire a firm that has both the experience and expertise necessary to determine the correct equity value of a business. Business valuations are as much of an art as a science, and an appraiser may use different approaches to derive the appropriate value. Ask to see the firm’s credentials and do some research to see what experiences other business owners have had with each firm. The firm should be experienced in different techniques and should be able to provide sample reports showing how they have used different approaches in order to calculate an accurate equity value.