You Know the Price, but What’s the Value?
March 24th, 2017
Let’s say you want to sell your restaurant business and are trying to determine how much to ask for it. There are two factors involved here:
Price, which basically is what the market will pay for it, given your assets, goodwill, the economy and other considerations;
Value, which gives you more of an idea of what your company is worth. This is where a business valuation comes in, usually based on a multiple of cash flow. But mere figures don’t tell the whole story. For example, if your financials match another restaurant, but yours is open just six hours a day for dinner services, it may have a higher value, and sell for more, than the other, which is a 24-hour-a-day restaurant.
A business valuation, or assessment, isn’t useful only in buying and selling businesses, however. You may need an accurate valuation when:
- Taking your business public.
- Applying for credit or a loan.
- Seeking outside investors.
- Disputing the conclusions of a CRA audit.
- Planning your estate.
- Dividing property in a divorce.
- Entering bankruptcy proceedings.
In Canada, the law doesn’t designate who is qualified to perform valuations, so it’s a good idea to talk it over with your financial planner. Your accountants may do the valuation for you or decide to hire someone to do it. The decision may be based on the purpose of the valuation. For example:
Estate taxes: you will likely want a valuation that’s as low as possible to minimize tax liabilities.
Sale: you will want documentation that shows the highest possible value.
Financing: bankers will look for a valuation that focuses on liquidation value rather than a company’s prospects as a going concern.
Litigation: you will likely want to set your valuation goals to match the side of the case you’re on.
There are two common approaches to valuations. The liquidation or asset value approach represents the amount expected to be realized on net assets in the event of a liquidation, after taxes and the costs of the liquidation. This approach gives the lowest value of the business.
The going concern value takes into account the ability of a business’s underlying assets to generate profits, which becomes goodwill when negotiating a price or determining fair market value.
Within those approaches, there are four universally accepted valuation methods:
Capitalization of earnings, which focuses on the historical accounting income of the business being valued.
Capitalized cash flow and the discounted cash flow, which are the most popular and view cash flow as a primary concern of business owners, and
“Rule of thumb,” which uses standards that have been identified for specific industries. A rule of thumb, however, is usually only used to complement one of the other methods.
Art vs. Science: Valuations involve a number of subjective decisions, each of which can affect the financial value of your business. When it comes to projecting expected earnings and rates of return the valuator must review the operations (financial, production, and marketing) of the business and consider the industry and the general economy when determining the value of a business.
Ups and Downs of Valuation
Value increases with:
- Adequate capitalization, and
- Well-regarded investors.
Value Decreases with:
- Poor capitalization;
- Unknown investors;
- Inexperienced management;
- Commodity technology or service;
- Stable or contracting market;
- Unimportant market position;
- Weak customer base;
- Ineffective operating teams;
- Inadequate gross margin;
- Projections of cash-flow deficit; and
- Low return on equity