The Importance of Valuations

by | Mar 1, 2022 | Blog

We’re often asked the question “Why do I need a valuation, especially if I have no intention of selling the business any time soon?” We always respond that knowing the baseline value of your business is the starting point for owners who want to effectively build a business with transferable value. Quite simply, valuations can be instrumental when it comes to accomplishing your objectives and knowing the value of your business (throughout its life cycle) can be a helpful and effective management tool. Following, we’ll explore several reasons why valuations are essential as your business continues to grow and evolve.

1. Valuations provide a baseline. Just like getting an annual physical at the doctor’s office, regular valuations provide a baseline. They serve as an indication of what you’re doing right and what you could be doing better. Some years your value may be up, other years it may be down a little bit (particularly in the event of a market correction). But without knowing your baseline, you have no solid evidence of how you’re doing. Think of a valuation as a health metric for your business that serves to measure your business’s blood pressure.

2. Valuations help chart the course for the future. Simply put, you don’t know where to go if you don’t know where you are. Valuations can help you determine ways to improve the business. Perhaps a valuation will indicate the need for a technology investment or hiring an employee. Maybe you’ll come to the realization that an expense can be reduced or eliminated. Valuations can often help an owner make a change to the business or assist with a decision they may have been having difficulty with.

3. Valuations measure progress. Performed regularly, valuations provide a pretty good measure of how you’re doing compared to the path you’ve set for your business. To be most effective, valuations should be utilized in tandem with your strategic business plan and should be referred to as a component of any significant decision.

4. Valuations can identify gaps. A comprehensive valuation will utilize key performance indicators (KPIs) to look at the non-financial aspects of a business that are actually the underlying value drivers. Examples are corporate structure, client demographics, technology usage, and firm infrastructure. KPIs are instrumental in identifying areas of potential improvement for the business – and ultimately provide ways to increase value.

5. Valuations help you manage your business. Valuations can and should be used as a powerful driver of how you manage your business. The purpose of a valuation is to track the effectiveness of your strategic decision-making process and provide the ability to track performance in terms of estimated change in value, not just in revenue. This helps you to take a holistic look at your business and make decisions that are highly impactful for your bottom line. It allows you to understand the subtle dynamics of your business and avoid unforeseen consequences of seemingly insignificant decisions.

6. Valuations create accountability. Now that you’ve utilized a valuation to identify gaps and set a path for the future (with measurable goals), you have, in essence, made yourself accountable for achieving those goals and can create discipline around them. Remember, this should be used as a component of your strategic business plan – because if you can measure it, you can manage it.

7. Valuations provide a benchmark. With little to no public data available on what businesses in this industry sell for (the vast majority of deals are never published), knowing your baseline value can allow you to benchmark yourself (via KPIs) against your peers, as well as “Best Practices” standards.

8. Valuations provide a perspective on price. When it comes times to transition (and all businesses will eventually transition), your historical valuations (remember, valuations should be an ongoing exercise) provide a starting point for price. Whether it’s an external sale or internal next-generational transfer, you now have an idea of what your business could be worth to a prospective buyer (though price is only one component of a deal). Owners often have an unrealistic valuation expectation – having a baseline valuation and understanding what drives that value can help eliminate any surprises down the road.

9. Valuations can provide the gateway to capital. If you are considering borrowing capital for an acquisition or other business investment, any lender will want to know what leverage lies in your business. Your valuation is the first step in the process of securing capital.

10. Valuations are part of your estate plan. For an owner, the business value typically represents 50-70% of their personal net worth. More often than not, owners fail to diversify the concentrated stock position they hold in their own business. Knowing how the business value impacts your personal financials can help you better plan for your family’s future.

Unquestionably, valuations serve many purposes and go well beyond “what someone would pay for your business”. Used properly, valuations allow you to see the inner-workings of what’s really going on in your business. That insight puts you in a competitive position as you strive to strengthen and increase the value and overall performance of the business.

The Importance of Valuations
Written by Truelytics