Businesses in Utah are thriving. First, it enjoys a strong economy even despite the COVID-19 pandemic. In the latest Rich States, Poor States report, it ranked first in terms of the economic outlook for the fourteenth time.
Companies, both big and small, are currently scrambling to look for workers as they recover. The one-year GDP change is almost 4 percent, according to Spectrum data, making it the eighth-best in the country.
In 2018, about 3 per 100,000 people closed venture capital deals, the eighth-highest among other ranked states. In the same year, VC funding reached over $1.2 billion or almost $370 for every resident.
It isn’t surprising that many individuals and companies, out of state or local, are on the lookout for possible mergers, acquisitions, and buyouts. They are also setting their sights on businesses for sale.
For those close to fulfilling their exit plan, being in Utah is already an advantage. If they intend to sell, then the market is already there.
But like other potential buyers, they don’t spend money right away on some random company. They research and, most of all, determine if they are worth the investment. Thus, sellers need to know one of the essential factors in the buyer’s decision-making process: the value of the business.
How to Know the Value of the Company
Many business owners trying to sell their enterprises often end up doing two things: (1) failing to do it because they overstate their value or (2) feeling shortchanged because they undervalue.
How can one avoid it? The answer is to talk to business valuation experts. Business valuation is the process of knowing the complete economic value of a company.
This is different from the fair market value, which is the price the goods will sell in the market or the amount a buyer is willing to pay. Economic value refers to the value a person—in this case, another entrepreneur—places on a product according to the economic or financial benefit it can derive from it.
Business valuation experts and buyers can consider a variety of methods to calculate a company’s worth:
1. Revisit the Financial Statements
Potential buyers may want to check the company’s financial statements, namely balance sheet, cash flow statement, and income statement, for a certain period. Usually, it is between one and five years, so they can see the growth—and the speed of acceleration or expansion—of the business.
Why can’t they consider only the revenue statement, though? It’s because profits alone do not tell the whole story. For example, they don’t entirely reveal the liquidity or the number of cash reserves the entity holds.
Sometimes revenues are high, but much of the cash is tied to hard-to-liquidate assets like real estate. In other cases, cash flow may be lower because companies continue to own idle assets like equipment.
It is also possible that the income statement shows a high profit, but the balance sheet will reveal a lot of high-interest-bearing debts. These factors do matter when they want to know the sustainability of the business.
2. Use the Multiples of Earnings Approach
The multiples of earnings approach is the process wherein a multiple is applied to the company’s earnings or income to identify its potential growth within the next few years or how much a buyer is willing to pay for the business if it goes on sale again.
This principle is not simple, and the multiples are not fixed as they can vary between industries. That is why working with a business valuation expert is extremely helpful.
For example, what income should one use? Is it EBITDA (earnings before interest, tax, and depreciation), EBIT (earnings before interest and taxes), or EBDT (earnings before depreciation and taxes)?
When it comes to tech startups, the multiples of earnings approach is often based on growth and revenue because of fast growth and high burn rate. Those that grow beyond 30 percent a year may use a multiple of 6. Thus, if the business earns $2 million this year, the valuation is $12 million.
3. Consider Other Factors
Business valuation experts and potential buyers may also look beyond the numbers and the financial statements and consider other factors that may affect the growth and profitability of the business. One of these is location.
Is it near its target market, or are the demographics changing? What types of businesses have been appearing over the last few years? What are the planned developments within the area? What are the chances of the company losing its space if developments occur?
Business valuation is both complex and tricky, but it effectively ensures both parties enjoy a win-win transaction.