A business’s value in the eyes of the owner often varies greatly than what can be found through the market’s lens. A proper business valuation with accurate financial statements avoids unnecessary questions from prospective buyers. Additionally, analyzing sale transactions of similar business can be very useful information of the business owner who is thinking of selling.
In a previous KLP posts, we’ve discussed the importance of using valuation skills to prepare a business for sale, and we focused on income statements and balance sheet adjustments. With accurate financial statements in place, a business analyst can start to look to the market for guides on the real value of the business.
A recent QuickRead article by Lone Peak Valuation Group principals Rick Hoffman and Jeff Pickett stated, “In this case, just as when employing the market approach to business valuation, the guideline firms are those firms in the marketplace of reasonably similar market focus, size, stage of development, industry, etc. However, as opposed to providing an indication of value, in this case, the guideline firms will provide valuable insight to the seller for maximizing the value of its firm. Thus, the data that is gathered is somewhat different than the data gathered when valuing the firm. In this case, the data is intended to act as a benchmark for performance rather than an indication of value.”
Financial ratios of the guideline firms will assist the business valuation, similar to traditional business valuations. However, it is often wise to gather data from firms that operating within the same industry that are within reach of being comparable by the expected sale date—instead of firms directly comparable today.
“Too often, analysts only think of firms as growing through an increase in revenue, so they only identify larger firms as being good role models,” Hoffman and Pickett stated. “Firms that have similar revenues but better profit margins should be sought after with earnest. It is also useful to err on the side of too many firms rather than too few.”
Identifying as many firms as possible for the firm will improve the study. However, it is a good practice to eliminate firms from the study that are multiple stages of development. “For example, if preparing a regional business, the analyst may consider firms that are on a national level, but are not international,” Hoffman and Picket stated.
Next, we’ll explore the typical ratio analysis and comparisons needed in a business valuation in an upcoming post. In the meantime, if you are located in Indianapolis and would value the input of a valuation professional as you begin to consider an exit strategy please give us a call today.