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Beyond the balance sheet

When is the right time to be valuing a business?

James Tillotson 29/6/2016 5 minute read

James Tillotson FCA explains exactly when valuing a business is both advantageous and necessary for owner-managers.

Whatever your reasons for being in business, owners and directors should always be working to develop and grow their company with the aim of building its value. An understanding of the valuation and how the concept can be used allows you to maximise the potential of your company, increase returns and improve investment decisions. It can also provide you with a better understanding of the funding options available to you along with how to best allocate people and resources to maximise efficiency.

This blog post will help you by highlighting the different circumstances in which such work is likely to be needed. Then as a business owner you’ll be better equipped to understand the relevance to your day-to-day operations and when you’ll likely need to obtain a valuation.

What is a valuation?

A valuation is the process of estimating what something is worth. A business valuation puts a price tag on a company. In the simplest terms, valuations are usually a total of assets (items owned that are both tangible and intangible a - bank balances, trade debtors and stock for example) and liabilities (any type of borrowing or future responsibility for payment or provision of services). However, all aspects of the business come into play when calculating how much it could potentially be sold for.

It's almost inevitable that a vendor will propose a different valuation to a purchaser and the old adage “its only worth what somebody is willing to pay” may, at first, appear flippant, but that is the reality and therefore it's important to be able to support your own valuation in order to be as persuasive as possible in any such related discussions.

Why should you value your business?

 

There are a number of reasons why you would want a valuation for the business and a brief overview of those reasons is listed below:

  • 1. Seeking finance

Funding from investors

A valuation matters to entrepreneurs when they’re looking for investors to finance their business. The valuation determines the share of the company they will give away to an investor in exchange for funding.

Consider this example where, as the owner, you’re looking for investment of £10,000 for a percentage of your business and the company has assets stated at only £5,000 in the accounts. A valuation may calculate the company's worth at £100,000 by taking its future growth potential into account.

Any potential investor would clearly need to understand and review your valuation model in order to satisfy himself as to why he was being asked to put in such a relatively high amount of money for a company whose assets were valued on paper at 50% of the value requested from the investor.

Funding through a loan

Many loans provided to businesses tend to be secured against other assets owned by that business (or against assets owned by someone connected with that business). The term "secured" refers to the fact that the lender requires something as a security in case the loan cannot be repaid (when a mortgage is secured against the property to which it relates). Secured loans contain less risk for lenders than unsecured loans so they usually come with more favourable interest rates and terms.

A properly considered valuation exercise for example, (and report thereon) will therefore help demonstrate and support the reasons as to why you have arrived at a particular value in respect of any such assets which, in turn, will assist a business owner in respect of their application for debt funding.

As mentioned above, unsecured loans may also be available but, in such a case, the loan isn't secured against such an asset, which would generally mean that the interest rate will usually be higher and the terms and conditions of the lending may well be more punitive to reflect the greater risk being taken on by the lender.

  • 2. Business transactions

M&A - Mergers and acquisitions

Mergers and acquisitions represent a moment in a business’ life when the process of carrying out a valuation is so very critical. Clearly, for the purchaser’s own strategic planning they will want to understand what the initial financial impact of such an investment would be as well as determining the likely financial benefits that the acquisition might bring in the future.

Both parties will probably have different ideas about value, the buyers price no doubt tends to be lower than that of the seller! This will result in a period of negotiation between both parties to arrive at a figure they’re both comfortable with.

Selling the company

There could come a time for a business owner to sell their stake in their company owing to the fact that:

  • It has always been part of the business plan to do so or;
  • They want to realise the value of their stake for personal financial gain or;
  • They want to dispose of their assets for financial planning purposes

A robust valuation will assist in ensuring the disposal is done in the most financially positive fashion. The party that should do the valuation first is usually the party that wants to initiate the transaction, and there will be a better chance of a sale being completed if both the buyer and seller agree with the methodology and approach taken.

  • 3. Incentives for growth

Management and employees

Regular valuations can be a good thing for your business because they provide:

  • Measurement of performance with associated incentives
  • Identification of areas of both strength and weakness in the business

That, in turn, can then provide management with a clear indication of how results are impacting on the business and hopefully progress made within the framework of the overarching business plan. If directors have a personal stake in the company then it also has potential implications in terms of their personal wealth and finances. Share option schemes provide a tried and tested way of rewarding and incentivising key staff in order to assist with the drive to increase the value of the business.

  • 4. Personal

Retirement planning

Individuals who are self-employed or owner-managers will often rely on their business to fund their retirement. They may be less likely to have diversified retirement planning vehicles and there is therefore likely to be more risk if your retirement plans are tied up in one asset. Carrying out a simple valuation from time to time will allow that person to check that everything is progressing in line with their plans (as well as allow for corrective action to be taken if not).

 

  • 5. Crisis situations

Bankruptcy

If such an unfortunate situation arises then it’s important to obtain accurate valuations in respect of the business’ assets in order to maximise the funds that might be realised so as to meet as many of the business’ liabilities as possible.

Death and divorce

In other unpleasant circumstances such as death or divorce, a valuation can eliminate uncertainties as to what assets may actually be worth so that they be split fairly or allocated per the individual’s wishes.

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The content of this post is up to date and relevant as at 29/06/2016.

Please be aware that information provided by this blog is subject to regular legal and regulatory change. We recommend that you do not take any information held within our website or guides (eBooks) as a definitive guide to the law on the relevant matter being discussed. We suggest your course of action should be to seek legal or professional advice where necessary rather than relying on the content supplied by the author(s) of this blog.

 

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