Tag Archives | business valuation

Protect Yourself: A Guide to Non-Compete Agreements

Oftentimes, businesses see their competitors as their biggest threat. But what if your star quality team continues to leave to join your competitor’s team? That is, in my opinion, the bigger threat. You have already invested in hiring, training, coaching, and developing those individuals. Then, they leave and directly compete against you. We see this commonly in consulting practices, but it occurs in every industry. In this week’s blog, we are taking a look at how to protect yourself and your company with non-compete agreements.

Non-Compete Agreements, Guide to Non-Compete AgreementsWhat is a Non-Compete Agreement?

A non-compete agreement is an agreement between the employee and the employer that attempts to prevent the employee from working for a competitor within a specified time period and geographical area. Furthermore, it must adhere to all state and national employment regulations. It is best to hire a labor law attorney to verify conditions and ensure that it will uphold in court.  The laws for non-competes and the effectiveness of non-competes vary greatly from State to State. In addition, ever changing laws and precedent will challenge the effectiveness of your non-compete.

According to the American Bar, a good non-compete agreement should prohibit a former employee from doing the following

  1. “… Working with a competitor
  2. … Soliciting former coworkers to be employed in his or her new company
  3. … Soliciting or disclosing confidential information, such as customer lists and data, learned in the course of their employment.”
If you want to protect your company’s future, then it’s important to know what could potentially destroy value. Identify “destroyers” that can impact your company’s value with our Top 10 Destroyers of Value whitepaper.

Why You Should Use Non-Compete Agreements

Take a look at your sales persons and/or consultants. They have developed a relationship with the client and have goodwill with that customer; however, if they decide to leave for whatever reason, then that positive relationship may be in danger. In addition, if that same sales person works for a competitor, then they may poach that customer with the goodwill they have already built up.

Non-compete agreements discourage employees from leaving the current company and competitors from poaching those employees. This only occurs if the non-compete agreements will hold up in court and if the company (you) will take the employee to court. I have seen non-competes work and prevent stealing customers and employees. I have also seen non-competes not hold up in a case. It all depends on the case law, the State you are in, and your luck with the judge hearing your case. 

Tip: A contract is useless unless you enforce it. You must be prepared to take a broken contract to court.
Discover if there are any “destroyers” in your business with our free Top 10 Destroyers of Value whitepaper.

Who Should Use Non-Compete Agreements

You should consider these agreements for employees, clients, shareholders, suppliers, and partners; however, non-compete agreements are typically reserved for executives, senior management, research and development, and key sales people. Not all companies should use non-compete agreements.

Non-Compete Agreements, Guide to Non-Compete AgreementsA Guide to Non-Compete Agreements

Here is our guide to non-compete agreements. It covers trade secrets, how to protect yourself, and how to protect your company’s future.

Trade Secrets

Trade secrets need to be protected, especially from competitors. A non-compete agreement helps you to protect those trade secrets in the case an employee leaves for a competitor. Also, your company hand book should remind employees that all inventions, ideas, patents, and creative work they develop while at work, is the companies property. Please check your local laws and precedents for more information.

Protect Yourself

The goal for having non-compete agreements with employees is to protect yourself (your company). As said before, non-compete agreements are usually intended for the key management team or anyone with a direct relationship with customers. It’s important that you understand your State law. Certain states, like New York, do not allow for companies to extend non-compete agreements too far down in the organization. The goal of non-competes to protect yourself from growing competitors or new competitors that may pop up as a result of key players building their own organization.

Protect Your Company’s Future

Protect your company’s future by protecting your most valuable assets – your human capital. Don’t let gaping holes in your employee policy leave your open for financial loss. The American Bar says that, “Having a valued employee defect to a competitor and take sensitive proprietary information such as customer lists, pricing information, marketing strategies, or product and service expertise with him or her can be a devastating blow to any business – large or small.”

Protect your company’s future with our Top 10 Destroyers of Value whitepaper.

Example: Consulting Firm

Let’s look at an example of a consulting firm! They are trying to prevent any client from hiring one of their leading sales person or a critical member of the team. In an consulting firm, the top challenge faces is when clients hire your consultants out from under you. For example, you hire Tammy to work 20 hours a week, 50 weeks out of the year. A client will pay $150,000 for a 1,000 hours of her work. As the owner of the consulting firm, you get 40% of the $150/hour. It’s a win-win situation. You fulfill a client’s need and fulfill Tammy’s need for business.

As the relationship further develops, Tammy and the client decide that they don’t need you. Unfortunately, this option only benefits Tammy and the client. It hurts you. If the client offers, $200,000 a year in compensation, then Tammy is pleased. She has consistent work, focuses on one client, and does not have to worry about any gaps in her hours. On the other hand, the client is pleased because they now have a full-time salaried employee that works 50 hours a week for 50 weeks a year.

Let’s calculate the price difference for the client!

Tammy’s previous hourly rate was $150.

With the client, Tammy costs the client $80 per hour. Divide $200,000 salary by 2,500 hours of work to come up with $80 per hour.

Furthermore, you have lost an income stream. Then you have to find, hire, and train a new employee – continuing to cost more and more. If you continue to loose more consultants, you will no longer have a firm. All employees and clients have left.

Non-compete agreements would have protected you from loosing your company.

Don’t Destroy the Value of Your Company

In conclusion, you should use non-compete agreements to protect the value of your company. There are many other ways to make sure you don’t destroy the value of your company. To improve the value of your company, identify and find solutions to those “destroyers” of value. Click here to download your free “Top 10 Destroyers of Value“.

Non-Compete Agreements, Guide to Non-Compete Agreements

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Intangible Assets: Protecting Your Brand And Reputation

“In an economy where 70% to 80% of market value comes from hard-to-assess intangible assets such as brand equity, intellectual capital, and goodwill, organizations are especially vulnerable to anything that damages their reputations” (Harvard Business Review). Last week, I had a conversation with one of my coaching participants, Dory. Dory’s company is trying to make a lot of changes. Changes that as a financial leader just doesn’t make sense. It involves repositioning the business. It requires new marketing, new branding, new value, new culture, new staff… It’s an entirely new brand! However, the leadership fails to see how making this large of a shift will not only change the brand, but it will also risk destroying the firm’s reputation. In this week’s blog, we are discussing about protecting your brand and reputation.

With 70-80% of value stemming from intangible assets – such as your brand and reputation – it’s important to know what your company’s strengths and weaknesses are. Start enhancing those strengths (and resolving those weaknesses) with our Internal Analysis whitepaper.

Protecting Your Brand And Reputation

In today’s world, protecting your brand and reputation should be a priority because it can be destroyed with one social media post. In a WSJ article, Keri Calagna, principal at Deloitte & Touche LLP and leader of Deloitte Advisory’s brand and reputation management services, says that, “brand and reputation are complex, difficult to measure, hard to predict—often a result of strategic and operational decisions—and influenced by factors outside of an organization’s direct control.” But there are things that you can do as an organization not to further diminish value potential.

Protecting Your Brand And Reputation, Protecting Your Intangible AssetsFor example, we have a client that recently experienced an incident near their facility. The client’s concern was reputation and responsiveness to the situation even though they were a third party to the incident. But the perception with regulators and potential customers is very important. So, our client went above and beyond to respond and assist in the situation. This was seen in a very positive manner with regulators, neighbors, and customers. As a result, they were building very positive brand equity.

Brand Definition

Business Dictionary defines brand as a “unique design, sign, symbol, words, or a combination of these, employed in creating an image that identifies a product and differentiates it from its competitors.” Over time, a brand becomes the face of the company, something that customers recognize, and conveys the value of the product/service. It is your Image.  For example, Coca-Cola is historically seen as the #1 soda producer over Pepsi. Coca-Cola’s branding efforts have created a culture and a value among consumers.

Brand equity can go either way – positively or negatively. For example, influencers, bloggers, neighbors, friends, and family have recommended Product A to you. As a result, you are most likely going to buy Product A and any other product you need from that company. Then, you come across Product B. Product B has been known for its poor quality and is generally not as effective as Product A.  Product A has positive brand equity, whereas Product B has negative brand equity. As a result, Product A has a lot more wiggle room to make mistakes than Product B.

Take inventory of your company. What does your company do well at? What weaknesses does it struggle with? Click here to access our Internal Analysis to take a complete inventory of your company. 

Reputation Definition

Cambridge defines reputation as “the opinion that people in general have about someone or something, or how much respect or admiration someone or something receives, based on past behavior or character.” In other words, the reputation is how customers perceive your company versus how they recognize your company.

Protecting Your Brand And Reputation, Protecting Your Intangible AssetsAlign Strategic Decisions With Brand

One method to protect your brand and reputation is to align it with strategic decisions and overall strategy. For example, a company makes a decision without factoring in its brand. Customers and potential customers do not agree with the decision make because it changes X, Y, and Z. We have seen companies destroy themselves because they do not consider all factors before making changes to their brand.

Know Where Breakdowns Occur

Generally speaking, any breakdowns in your company will have to do with your human capital. If there is a misalignment with the actual company culture (not just what you perceive) and the brand, then your team will not be able to successfully deliver what the brand promises. Educate your employees on the brand. Fix issues within your team before it’s vastly different than the brand you are putting out there.

Protecting Your Intangible Assets

In the end, brand and reputation are intangible assets that your company needs to care about. It impacts value potential and the bottom line. Instead of managing crises, let’s look at how to manage risks and consequently, protect your intangible assets.

How does a company protect its intangible assets? Protecting your intangible assets starts with knowing what they are. What is your company known for? Why do customers choose you over a competitor?

Then start to identify what could change those answers. Is it government regulations that will change your product? What about material changes?

Finally, package what your intangible assets are and what influences them. Manage any risk threatening those assets.

How Your Brand And Reputation Impacts the Bottom Line

Before you go about making any changes to your brand, look internally at what is reliant on that intangible asset. In my first example, Dory’s leadership was not looking at how the employees, customers, vendors, investors, etc. were tied and attached to the brand. If her company made the change they wanted to, the company would lose its employees, customers, vendors, and investors. Sometimes, the brand is the thing that has made you so successful. If you are protecting your brand and reputation from potential changes, then take a look at our free Internal Analysis whitepaper. This will help you get a high level view of what impacts what.

Protecting Your Brand And Reputation, Protecting Your Intangible Assets
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Planning Your Exit Strategy

When you start a company, you should generally know how you are going to exit the company. It could be a merger or acquisition, leave it to family, an initial public offering (IPO), a management buyout, etc.. Whatever the case, planning your exit strategy is almost as important as running your company because it’s the end goal. If you go into a business without the end in mind, then you may be building your company for the undesired exit. Before we go into planning your exit strategy, what is an exit strategy?

Planning Your Exit Strategy

What is an Exit Strategy?

Investopedia defines an exit strategy as “a contingency plan that is executed by an investor, trader, venture capitalist, or business owner to liquidate a position in a financial asset or dispose of tangible business assets once certain predetermined criteria for either has been met or exceeded.” When an exit strategy is implemented, the valuation process begins. Traditional approaches to valuation require the company to present their financial statements, cash flow models, and competitive analyses comparing companies in a similar field or industry.

Cleaning up your accounting records is just one method to protect your company’s value. Read about ten other “destroyers” that could be taking value away from you in our Top 10 Destroyers of Value whitepaper.

Why is Planning Your Exit Strategy So Important?

Exit strategies are crucial to responding to issues like the following:

  • Divorce of an owner(s)
  • Lawsuits
  • Change in market conditions
  • Retirement
  • Cashing out
  • Death

When you inevitably run into this life events, it’s either going two ways: according to plan OR some way. The second option leaves you open to a lot of unwarranted risk. It could also go really well or it could be a disaster. You would never know though without a plan in the first place. Of course, no plan is going to be perfect; however, it does allow you to think of solutions outside a stressful environment.

Planning Your Exit Strategy

Planning your exit strategy requires you to think from two different angles – business and personal.

Business Exit Strategy

Planning your exit strategy can take a long time. Sometimes, it can take years. It is certainly not something that is done in a month or two. There are many things to take into consideration when planning your exit strategy, including the following:

  1. Where are you personally in life?  Are you young, mid life, or of retirement age?
  2. Where is your company? Is it a mature company with a lot of good historical financial records? Or is it a young startup?
  3. Or are your accounting records less than perfect?
  4. What is the condition of your industry and the general economy?
  5. Is your product or service technology based?
  6. Is your management team ready to take over?

These are just some things to think about as you plan your business exit strategy.

While you are planning your exit strategy, it is a great time to start identifying “destroyers” in your business that are taking away value. Click here to learn about the Top 10 Destroyers of Value.

Planning Your Exit StrategyPersonal Exit Strategy

Personal exit strategies are going to take a little different approach. Life events like death, illness, divorce, relocation, retirement, etc. are going to happen. If you are the owner of the organization, then start listing all of the potential situations that would impact your company. Write those specific plans down, and share them with the people that need to know – other owners, spouse, attorney, etc. The key is to let others know. If you spend your valuable time writing and developing an exit strategy, then the people that are carrying out need to know what the plan is and where to find it.

Valuation

The valuation process helps determine the economic the company. We all have some magic number that we would love to have once we sell our business, but is it realistic? Find out what your company is really worth well before you decide to sell. Listen to advisors and be realistic. I have had many entrepreneurs tell me their company is worth $X, just because that is what they want. After all, they did put their entire life into it. Well, just because you want $X, it does not mean you will ever sell it for $X. Remember, a sale actually takes place between a willing buyer and a willing seller. Understanding what your business is worth is not that difficult to do. Valuations also change considerably with time, markets, and the economy. So, timing your exit is critical.

Read about business valuation methods and purposes here.

Here are a few questions to ask when valuing your company:

Goal of Planning Your Exit Strategy

There is one major goal of planning your exit strategy: don’t leave any value on the table. If you are not ready to get out of the business now, then this is great opportunity to identify and address those destroyers of value that are taking money off the plate. Click here to access our free Top 10 Destroyers of Value whitepaper to prevent leaving any value on the table.

Planning Your Exit Strategy

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Free Cash Flow Definition

See also:
Discounted Cash Flow Analysis
Valuation Methods
Free Cash Flow Analysis

Free Cash Flow Definition

The business is like a human body, the body needs blood, the business needs cash. Investor look at Free Cash Flow to make their decision for investment. Interestingly, it’s not a number you can come up easily. First, let’s look at the free cash flow definition. Many business owners, somehow, are not familiar with Free Cash Flow. The Free Cash Flow definition is cash generated by the company after deducting capital expenditures from its operating cash flow the amount of. In other words, after the company pays for employees, debts, expense, fixed assets, rent, plant, etc., whatever money you have got left (“left-over money“) is called Free Cash Flow.

FCF Example

For example, a company has $1 million cash flow from operating activities in its financial statement. However, they are spending more than $900,000 on purchasing property plants or replacing equipment. In this case, the investor will have to analyze the business to see if it was either a poor management decision or a high growth opportunity (i.e. more investment than cash on hand).

Even when a company makes positive Net Earnings, it doesn’t necessarily mean that company has Free Cash Flow.


If you want to improve your company’s cash flow, we have put together the 25 Ways To Improve Cash Flow (which you can access for free).

Click here to Download the 25 Ways to Improve Cash Flow


Why is Free Cash Flow Important?

As it mentioned above, cash keeps the business running. If your company has Free Cash Flow, then what should the company be spending the money on? They could either hire more employees, invest in other assets, issue dividends, or make more acquisition. Before you make the decision, there are 3 main reasons you would consider FCF as a competitive advantage to maintain the business growth rate.

Free Cash Flow to Equity (FCFE)

FCFE measures the Equity value, referred as “levered” cash flow. It’s the amount of money available for equity shareholders after paying all expenses, debts, reinvestment. Also, consider free cash flow to equity as an adjustment for debt cash flow.

Free Cash Flow to Firm (FCFF)

FCFF measures the enterprise value, referred to as “unlevered” cash flow. Free cash flow to firm shows available cash to all investor – both debt and equity. In an Unlevered Discounted Cash Flow analysis, you would use WACC (Weighted Average Cost of Capital).

Valuation using Free Cash Flow

Other than using DCF method (Discounted Cash Flow), use Free Cash Flow to estimate the present value of a business.

FCF = Present Value.

By calculating free cash flow, you can interpret discretionary cash flow of the company. If FCF is positive, then the company has many options where to put the money in. Whereas if FCF is negative, then you have to analyze if it’s a one-time issue or a recurring problem. If it’s constantly negative, then the company has to raise more money (debt or equity) or eventually has to restructure itself.

Free Cash Flow Formula

The free cash flow formula is very simple. Look at the Cash Flow Statement. Subtract Capital Expenditures from Operating Cash Flow.

Free Cash Flow = Cash Flow from Operation – Capital Expenditures

Operating Cash Flow

Operating cash flow is the amount of money required to fund a company’s normal operation. It’s usually in bold and always show before Financing and Investing Cash Flow. You can also refer to Operating Cash Flow as “Working Capital“.

 Capital Expenditures (CAPEX)

Find Capital Expenditures (CAPEX) in the Cash Flow Statement, under Cash Flow from Investing Activities. However, Capital Expenditures is sometimes listed as Purchase of Property & Equipment. Capital Expenditure is different from Operating Expense (OpEx).

If you want to increase cash flow, then click here to access our 25 Ways to Improve Cash Flow whitepaper.

free cash flow definition, Free Cash Flow Formula
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Why Valuation Matters

why valuation matters The other day, a client asked why valuation matters. It seems like a lengthy process that is complex and differs in each case. You see, I didn’t respond in an elaborate explanation of the different methods of valuation. Instead, I start off by saying that life is very unpredictable.

Have you ever experienced a life-altering moment (good or bad)? One moment, you are driving; then the next, you are upside down. In another moment, you walk into the office proud of the company you built. Then the next, you are being served with a suit that will put your company out of business. In a less severe example, you may have everything together for the day, only to spill your hot coffee everywhere. Life happens. And unfortunately, there’s nothing that we can do to take the uncertainty out of it.

But there are things you can do to prepare for those unexpected moments. For example, you learned how to punch out a car window in the case of an accident. In another example, you never start a project or venture without completing a full SWOT analysis so that you can minimize any legal risks. Or you simply learned not to carry too many things – especially with hot liquids.

But have you ever thought about the value of your company? You might be thinking why valuation matters. My health is good. My life is good. And the economy is good. We all know that some things in life just happen, beyond our control.

In fact, when our founder, Jim Wilkinson, unexpectedly passed away last June, we found our answer on why valuation matters. You can’t wait for life to just happen to react to it. Preparation will make everyone’s lives less stressful and more productive.

Why Valuation Matters

Before we go into why valuation matters, we need to know what valuation is and why a company needs to be valued. Valuation determines the economic value of a business, asset or company. Although the goal is to determine the fair market value, there is no one way to be certain of the ultimate price paid. Typically, it depends on many factors including industry, sector, valuation method and the economic conditions.  You can also count on a fact, you can have your business valued by two professionals and you will come up with two different answers.

A company needs to be valued if it is being bought, sold, or liquidated. Sometimes a company must provide a value of its assets or company as a whole to raise debt also. A valuation professional typically employs the financial statements, cash flow models, and market analysis. In other words, they are going to look at the discounted cash flow (DCF), market valuation multiples, and comparable transactions. A strategic buyer will also value your company. They may use some of the methods already mentioned, but they will also look at your management team.

Believe it or not the status of your accounting records will also influence the value of your company. Especially when you are looking to sell the business. I have been told twice by Investment Bankers (I.B.) that having clean accounting records based on U.S. GAAP vs. Not having good accounting records based on GAAP can have a difference of a multiple of 1 x turn of EBITDA by one I.B., and the other I.B. stated a difference of 20%-30% of value. That is because if you do not have good clean accounting records based on U.S. GAAP, how are they ever supposed to have confidence in your reported EBITDA or Net Income? The buyer will need to build a cushion for his acquisition, even if they love your company and are a strategic buyer.

why valuation mattersHow To Deal with Valuation

When dealing with the valuation process, it is important to get as many facts as possible with 1-2 clear goals. Why are you valuing? What are you trying to accomplish with this valuation? You need to assess what the purpose of this valuation is.  It could be shareholder disputes, estate planning or gifting of interests, divorce, mergers, acquisitions, sales, buy-sell agreements, financing, and purchase price allocation.

To identify areas of improvement for your company’s value, it would be wise to identify any weaknesses or threats that are destroying your value. Click here to download our Top 10 Destroyers of Value whitepaper. Don’t let the destroyers take money from you!

Valuation for Mergers, Acquisitions & Sales

Interested parties during a merger, acquisition, or sale need to obtain the best fair market price of the business entity.  They need to look at their return on their investment.  (your company is their capital being deployed).  This will ultimately be negotiated between the buyer and the seller.

In buy-sell agreements, you transfer equity or assets between partners and/or shareholders.

Valuation for Estate & Gifting

Death is a fact that everyone is going to face. But the timing of that event varies for different people. If your business is part of your estate, you need to conduct a valuation of your business. This can be done either prior to estate planning, gifting of interests, or after the death of the owner.

The IRS also requires this type of valuation for charitable donations.

Valuation for Disputes (Shareholder or Divorce)

When a couple divorces, they need to divide the assets and business interests from one another.

Occasionally, a breakup of the company is in the shareholder’s best interests. This could also occur when shareholders are withdrawing and need to transfer their shares.

Valuation for Financing

Banks hate risk. As a result, they need to validate their investment in your company before they provide capital. At this point, they request for a business appraisal of your assets.

Valuations are important, but there are “destroyers” that are lurking to limit the value of your company. If you are valuing your company, click here to download our Top 10 Destroyers of Value guide.

why valuation mattersPricing Your Deal Right

There is no one way to value a business and there are multiple valuation approaches, including Income, Assets, and Market. Valuation can be a very complex process. It can also bring up issues that weren’t previously addressed – such as an owner’s differing interest from the other shareholders. In order to price the deal right, you need to figure out which approach will best work for your company and which one really applies.

There are three primary business valuation theories that fall into the following groups:

Income Approach

The income approach determines a company’s value based on the income. This may include:

Asset Approach

In comparison, the asset approach determines business value based on the assets of the company. This is where you might engage an appraiser to discuss value of assets based on market value and possible liquidation.

Market Approach

The market approach decides the value by comparing it to similar companies. A valuation professional will focus on the comparative transaction method. Then, they will appraise competitive sales of comparable businesses to estimate the economic performance of revenue or profits.  This works well with publicly traded companies where earnings information is readily available or when looking at real estate it is easy to find recent comparable transactions.

Valuation Destroyers to Watch Out For

There are a couple valuation destroyers to watch out for. Hopefully, you aren’t in a moment where you have to value immediately and are just preparing for a potential event. Some of the destroyers of value include having:

  • No recurring or consistent revenue
  • No good accounting records
  • A lack of clear direction or a weak management

To discover other potential destroyers of value and to learn about the above three destroyers, click here to access our free Top 10 Destroyers of Value whitepaper.

why valuation matters

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Access your Exit Strategy Checklist Execution Plan in SCFO Lab. The step-by-step plan to get the most value out of your company when you sell.

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What is your business worth?

So, you’re considering selling your business.  Whether it’s to pursue new opportunities or to get out while you can, you need to start thinking about your business from a valuation standpoint. Even if you don’t intend to sell your business in the near future, building a business to be sellable is a sound strategy.  So what is your business worth?

When It’s Time to Leave

How do you know when it’s time to leave? If you’re experiencing these signs, you should strongly consider creating an exit strategy for your business:

Sick and Tired

Sick and tired… Literally. Entrepreneurs by nature are constantly looking for new opportunities. As a result, business owners often feel tired, fatigued, and overwhelmed by the business. Imagine constantly building your business for 25 years… it never ends, and it gets exhausting! The natural reaction is to look elsewhere, but before you start searching for the next big thing, you have to take care of your current business first. After all, it is your creation.

Declining Revenues

Decline in company revenues. A decline in revenues is never a good sign for a company. Let’s say that you’ve been trying new methods for years now, but revenues continue to decrease. Even zero growth is a red flag that you should take action.

Keep in mind, some business owners make their decisions based on this one reason, and some make a move based on a multitude of decisions built up over time.

Market is Declining

The market for your business is declining. I used to work with someone that owned a small business before the attack on the twin towers. He flew in nurses internationally to work in his medical business, which provided him steady cash flow and a healthy bottom-line. The demand was also constant… until the terrorist attacks on 9/11. From that moment, it was more difficult to operate a business that relied upon flying in workers from other countries. The delay of bringing in nurses wreaked havoc on his business. Because of this difficulty, he decided to create an exit strategy.

When market changes are out of your control, the best thing to do is prepare. Getting your exit strategy ready before market changes force your hand is better than waiting for it to crash.

Partner Disputes and Relationships

Starting a business with partners is easier than exiting a business with them. This may be a legal issue, as easy as looking at a contract.

Sometimes, it does get ugly. Facebook is a great example. If you’ve ever seen “The Social Network,” you’ll probably recognize this story. Mark Zuckerberg and former business partner/investor Eduardo Saverin started Facebook together, but when Saverin displayed breach of fiduciary duties, Zuckerberg diluted Saverin’s stake in Facebook. This ended with Zuckerberg’s majority ownership and Saverin’s minimal-to-nothing ownership.

How would this relate to your business relationships? When starting a business, you want to choose a partner that will be able to carry out responsibilities completely. You also should flesh out your contracts, terms, and exit strategy.

“Life is like a box of chocolates; you never know what you’re gonna get.” Things happen in life, like getting married, divorced, sick, and busy.  What are your priorities as a person – what do you value most? Is a business more important than your family, or vice versa?

Are you in the process of selling your company? The first thing to do is to identify “destroyers” that can impact your company’s value. Click here to download your free “Top 10 Destroyers of Value“.

Assessing Valuation Methods

There are different methods to assess the value of your business. Many of these methods are specific to the type of business you have.

Asset-Based Valuation

This method, as the name indicates, calculates total asset value minus total liabilities. This method is criticized, however, for its ambiguity in valuing assets. The assets may not have been recorded on the balance sheet, or may be unique or custom products that are difficult to value.

The method is best used when focusing on real estate or other similar investments.

EBITDA Valuation Multiple

This is the most popular method, and usually references the market in relation to your business.   Businesses typically sell for 3X-5X EBITDA, but this can vary widely depending upon the type of business and the buyer. The ratios are calculated by taking the market value of a business, and dividing it by EBITDA.

According to ValuAdder, EBITDA valuation multiple removes the following when you value your business:

Who should you give the valuation to?

Conclusion

Investors or buyers calculate the value business based on more than just numbers. You might be selling to a current employee, someone well-versed in the industry, or a friend. There are many reasons a business owner might sell the business – relationships, cash flow, new opportunities.  Both the buyer’s and seller’s motivation will affect the price of a business, so it’s important to consider all of the angles and ensure that the method of valuation you choose accurately assesses the value of your business.

Want to know some of the things that may be hurting the value of your business?  Check out our whitepaper Top Ten Destroyers of Value to see where you might be leaving money on the table.

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Business Valuation Purposes

See Also:
EBITDA Valuation
Valuation Methods
Multiple of Earnings

Business Valuation Definition

Business valuation is the process of determining the economic value of a business or company. It assesses a variety of factors to determine the fair market value in a sale, but there is no one way to verify the worth of a company. Business valuation can depend on the values of the assessor, tangible and intangible assets, and varying economic conditions. Business valuation provides an expected price of sale; however, the real price of sale can very.

Traditional approaches to business valuation employ financial statements, cash flow models, and comparisons to competitive companies within a similar field or industry.

Business Valuation Methods

Income Approach: determines business value based on income. This type of valuation focuses on net cash flow, discretionary cash flow, and capitalization of earnings.

Asset Approach: determines business value based on assets. This type of valuation focuses on both asset accumulation (assets minus liabilities) and capitalized excess earnings.

Market Approach: determines business value in relation to similar companies. This type of valuation focuses on the comparative transaction method and appraises competitive sales of comparable businesses to estimate economic performance looking at revenue or profits primarily.

(Are you in the process of selling your company? The first thing to do is to identify “destroyers” that can impact your company’s value. Click here to download your free “Top 10 Destroyers of Value“.)

Business Valuation Purposes

Although the primary purpose of business valuation is preparing a company for sale, there are many purposes. The following are a few examples:

Shareholder Disputes: sometimes a breakup of the company is in the shareholder’s best interests. This could also include transfers of shares from shareholders who are withdrawing.

Estate and Gift: a valuation would need to be done prior to estate planning or a gifting of interests or after the death of an owner. This is also required by the IRS for Charitable donations.

Divorce: when a divorce occurs, a division of assets and business interests is needed.

Mergers, Acquisitions, and Sales: valuation is necessary to negotiate a merger, acquisition, or sale, so the interested parties can obtain the best fair market price.

Buy-Sell Agreements: this typically involves a transfer of equity between partners or shareholders.

Financing: have a business appraisal before obtaining a loan, so the banks can validate their investment.

Purchase price allocation: this involves reporting the company’s assets and liabilities to identify tangible and intangible assets.

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