Determining the Market Value of a Company
If you’ve struggled with uncertainty in valuing your company, then it’s time to dive into understanding market value of a company. A company’s market value should provide a fair and unbiased assessment of the value of your business in its whole state. The market value will vary from your company’s book value. Ideally, it will prove a higher worth than the book value. That’s a relief for most business owners.
When looking at market value, investors and potential sellers will use specific factors. These factors include possible growth, risks, your EBITDA, and concentration regarding customers and products.
These factors play key roles in valuing a business because it provides a realistic picture of what a buyer or investor should expect from the company. In terms of daily operations and future obstacles or success, the book value of a company simply isn’t enough.
Understanding Business Values and the Open Market
How the owner of a business values their business may be dramatically different from the company’s market value. Most business owners rely on their financial documents to estimate their value. Book value is the company’s total assets minus the total liabilities, including depreciation. Alternatively, publicly traded companies would calculate book value differently by dividing their outstanding common shares by the stockholder’s equity.
Book value is one method for business valuation, but it’s not the best. The open market nature of our nation means that investors or buyers know that they aren’t purchasing what the company is, they’re buying into what it could be.
Buyers and investors show the biggest interest in elements that aren’t present in a company’s book value. They will calculate their expected ROI. However, they want an honest layout of the risk factors and possible growth opportunities. This element of the open market value can sway a potential buyer’s decision.
Growth and Risk Projections
Uncertainty is the key word of this portion of a market valuation. Through various valuation models and equations, business people have spent decades, if not centuries, trying to pin down expected growth in company size and cash flow. Of course, with growth possibilities, comes various risks.
Typically business owners rely on a straight-line growth rate or a compound growth rate calculation. These both use past performance to indicate future expectations. They also present a more conservative approach to growth projections, which can boost confidence in potential buyers.
A high growth rate could bring in numerous buyers and investors. If you don’t balance that out with manageable risk projection, you could lose all of that interest. Risk is a huge factor, and while anyone buying a business is certainly making a gamble, they want a fair look at the odd before they throw their money in.
Risk calculations present many issues because it’s more concept and feeling than hard numbers. The riskiness of negative cash flow, chances of bankruptcy, and default risk are the key focus. In the past, some companies have really turned it around, but these are the long-shots and certainly aren’t common. To get to the root of possible risk regarding cash flow, bankruptcy, and default, a valuation will look at labor and management resources in addition to current financial stability.
If there are downfalls in management or labor, the situation will demand more from the investor or buyer. That would substantially bring down the value of the business. Other factors won’t go overlooked. Competition, predictability in the industry, diversity, and marketability also factor into risk projections.
Publicly traded companies have a more straightforward approach to calculating risk. They will divide the sum of dividends and stock buybacks by the complete value of the market.
Your Earnings Before Income, Taxes, Depreciation, and Amortization serves to give a clear image of the business’ financial stability and performance. It gives a heavy amount of weight to earnings but removes elements such as capital investments. By leaving in the cost of goods sold, as well as the selling, general, and administrative expenses
The EBITDA metric usually gives a good indicator of the company’s current performance and is a type of proxy for cash flow. A buyer could determine if certain risk factors were a result of poor financial planning or management through the EBITDA. It can also expose a company’s value that could have been inflated from questionable accounting practices.
Finally, EBITDA has such a substantial impact because the EBITDA metric showcases the true potential profitability. It outlines how much work a buyer might need to put in to exercise that profitability and how much revenue the company loses to COGS and SG&A.
The only struggle that comes with EBITDA usage in a valuation is that it’s not recognized broadly under the United State’s Generally Accepted Accounting Principles or by the SEC as a measurement of cash flow. However, there is an outstanding acceptance of this among business people.
Customer and Product Concentration
Concentration is often downplayed, but it can be critical in deciding how to value your company. But for any reason that could be a benefit, it may also be a downfall. These are your double-edged swords.
For example, if you have an extremely diverse customer concentration, it may be a concern that a market shift could have a drastic impact. Conversely, having too few customers would be an issue because losing even one customer or account would impact the business.
In theory, there shouldn’t be any single customer or account supporting more than 10% of the business. However, that may still be a bit conservative. If one customer makes up 10% of the business, and then a small handful comes together to support more than 50% of the company, it could lower its value.
There are ways to offset this decrease in value. When looking at product concentration, which can have the same effect as customer concentration, there are clear examples of beneficial intentional hyper-concentration. One outstanding one is Apple. Until recently, Apple prided themselves on saying “no” to good ideas to bring the outstanding ideas to life. Steve Jobs regularly talked about fitting the company’s entire product line on a small table. Apple took a pitfall and bragged about how great it was, and they were right.
Customer concentration, product concentration, and even market concentration need careful consideration. As part of the company’s value, what could seem like a downfall could justify another part of the valuation or explain away a buyer’s concern. Additionally, what could seem like a win may make buyers nervous, such as an overly diverse customer portfolio. When valuing your company, you’ll want to think through all the possibilities.
Can You Determine the Market Value of a Company with Similar Revenues and Profits within Your Industry?
After a professional valuation of your business, you might start to wonder exactly what it means for your place in the industry. Comparing the market value of a company will always start with your completed valuation in hand. If you only look at EBITDA exclusively from one company to another, it won’t give a full picture for a complete comparison. You want to see all the parts and the whole.
To some degree, comparing one valuation to another can give you an estimate on which is the more desirable investment. However, you can’t overlook elements such as reputation or management teams. Will those teams stay if someone else purchased the company? Would the fans of the company remain loyal if it changed hands?
When comparing businesses, you’ll want to evaluate revenue level, profit, reputation, and EBITDA. It might be apparent that “similar” businesses have drastically different values and profits. For example, Apple’s EBITDA at the year-end of 2019 was $78.6 billion, whereas Samsung’s was $51.6 million. Both have varying reputations and different revenue levels, although they’re known as direct competitors within the electronics industry.
Should a Market Value of a Company be Professionally Valued?
Absolutely! A professional valuation will look at your company’s raw elements without the biased lens of a business owner or employee. It can help you better understand your company’s strengths and weaknesses and is a valuable tool even if you’re not looking to sell your business. A valuation will look at how your company has performed, what you should expect in the near future and a realistic depiction of your assets and cash flow.
If you have concerns about your business’ core operations, then a valuation might expose management problems and troubling financial decisions. It can also bring particular challenges with concentration to light.
Most businesses lean toward having a professional value the market value of a company when they’re looking to sell or bring in investors. These are great reasons for a valuation. If you’re looking to get some investors involved in your business, you want to cultivate an honest relationship and a transparent look at the company. When it comes to selling a business, knowing where your company’s value stands in comparison to others in the industry can make your company a more desirable purchase or help the buyer make a better-informed decision.
To learn more about the Market Value of a Company, Call American Fortune for dependable Business Valuation Services at (800) 248-0615.