What is the importance of valuation in business?

A business is often a significant asset in an Entrepreneur’s life, and its value can be the culmination of a life’s work. For this reason, when considering selling your business, planning your future exit strategy, bringing on board a strategic partner/investor, or even raising finance it is essential to have a realistic understanding of your business’s value to make the deal work optimally. This is best achieved through getting an independent valuation.

The downside to getting your valuation wrong is underselling your business or more likely, in our experience, building unrealistically high expectations that could slow down or compromise your ability to carry out a potential transaction. This will be significantly more expensive than getting an independent valuation.

The upside to having an independent professional valuation is that it will go a long way to convince the counterparty that the valuation is realistic, and will also help manage your own expectations. With an independent professional valuation, you will be able to leave the professional valuer to defend the valuation, allowing you to focus on extracting maximum value from the deal.

Doing a valuation of your business requires a high level of skill. It is a technical piece of work that requires a thorough financial knowledge. Valuations require a detailed understanding of a company’s cash flow, income statement and balance sheet as well as deep insight into the company’s business model and growth strategy. A realistic valuation requires a good understanding of the specific markets and sectors within which the company operates, as well as broader macro-economic factors. There are also a number of factors outside of the company’s traditional numerical parameters that influence what a strategic buyer would be willing to pay for a company. Moreover, there are numerous different valuation methods that can be applied and a good valuation never uses one approach only.

Valuation work has elements of science and elements of art. It is possible to generate a theoretical valuation of a business but, as we have seen on numerous occasions, there can be a stark difference between a valuation prepared on an academic basis and the true value that a company would sell for in the market. A reasonable valuation requires both technical skill and a deep understanding of the commercial reality of running and selling a business.

When assessing your valuation expert make sure they have the technical skills but more importantly make sure they have successfully run, bought and sold businesses. This combination will cover both the science and art of valuation, and ensure the final answer is reasonable and defendable.

As a final thought, even if you aren’t planning to sell your business, the process of valuing your business will allow you, as a business owner, to identify the specific areas and variables in your business that create or destroy value and its twin sister cash flow. This will allow you to put in place a targeted strategy to build cash flow, and in turn build value. Many business owners run their business based on variables that, whilst important for operational purposes, are not necessarily value-driving. A firm and comprehensive understanding of what creates value may inform strategic and tactical decision-making.

Andrew Meerburg is the Head of Corporate Finance at The CFO Centre.  Andrew is passionate about helping businesses grow using Corporate Finance solutions.  His focus is on the buy and sell side advisory services, exit planning, finance raising, valuations, BEE ownership structuring and financial modelling.