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3 Reasons For a Business Valuation Besides Selling

By Quiet Light
| Reading Time: 7 minutes

Contrary to popular belief, selling your business isn’t the only reason you may want to consider getting a valuation. In fact, when done right, the valuation process can help you run a more profitable and streamlined operation even if you aren’t heading for the exit anytime soon.

In this article, we discuss how a business valuation works as well as three reasons to get a business valuation that you might not have expected. These include:

  • Discovering hidden opportunities and driving growth
  • Identifying risk and making your business stabler
  • Learning the unique strengths and weaknesses of your business

Related Article: Tips to Increase Your Website’s Revenue

How a Business Valuation Works

Before we jump into the specific reasons why you may want to get a business valuation, it is crucial to know how a valuation works in the first place. As a business owner, understanding the general business valuation process will help you recognize the true value that a good valuation can bring to your business operations.

“According to the SDE multiple method, the value of a business is equal to the SDE, or seller’s discretionary earnings, times a number, called the multiple.”

The SDE multiple method for valuation

There are many ways to value a business, including the fair market value method, discounted cash flow analysis method, and book value. However, the most common way to value a private online business is the SDE multiple method.

According to the SDE multiple method, the value of a business is equal to the SDE, or seller’s discretionary earnings, times a number, called the multiple.

Business value = SDE x multiple

While it may seem simple on the surface, a lot of important information goes into estimating both the SDE and the multiple.

The seller’s discretionary earnings are the total benefit the business provides to the owner. It is similar to profit but with some important differences. These differences make it a more useful figure for estimating the true money-generating capacity of a business.

To calculate SDE, start with profit and add back all allowable discretionary expenses. These include:

  • Taxes
  • Interest
  • Depreciation
  • Amortization
  • Owner’s salary
  • Unrelated expenses or income
  • One-time investments

This is not a full list. It is extremely important to add back all discretionary expenses to determine an accurate SDE figure for your business. Failing to do so will lead you to significantly undervalue your business.

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Understanding the multiple

Two businesses with identical SDE numbers could nevertheless have very different overall values. The multiple accounts for these discrepancies. The multiple is a number that captures tangible and intangible factors that influence the overall value of a business.

There are many such individual factors. For the sake of organization, all of these individual factors can be grouped under four main categories known as the Four Pillars of Value. The Four Pillars include:

  • Growth
  • Risk
  • Documentation
  • Transferability

To put it simply, businesses that have strong growth trends and future growth prospects are more valuable than those that do not. The more risk a business has, the less valuable it will be, and vice versa. A business with clear and orderly documentation is more valuable than one that lacks clear documentation. A business must be able to be transferred to a new owner without negatively impacting performance for it to have value. The easier it is to transfer, the more valuable it will be.

“To put it simply, businesses that have strong growth trends and future growth prospects are more valuable than those that do not.”

Why you should work with a business Advisor during your valuation

An accurate business valuation requires you to correctly calculate SDE. At the same time, it requires an accurate estimate of a reasonable multiple value. If you do not have experience in these matters, it is easy to make errors when making these calculations. Even small errors could mean dramatically over- or undervaluing your business.

At the same time, a quality business valuation by a true valuation expert provides much more useful information than just the estimated dollar value of your company. An experienced business Advisor or valuation professional will provide you with a detailed business valuation report that explains the many factors that go into calculating value.

This information is priceless for anybody interested in improving their business. Think of your valuation as a thorough health checkup for your business. It lets you know what’s working, what’s not working, and what you can do to fix it.

Now that we have an understanding of the valuation process, we’ll explore three key reasons why you should consider getting a valuation, even if you aren’t planning on selling your business anytime soon.

1. Use Valuation to Discover Hidden Opportunities and Drive Growth

One of the best ways to increase the value of your business is to drive consistent growth. In addition to raising your income, growth also helps to increase the expected payout you receive when you do decide to sell your business.

The information you glean from your business valuation can help you identify hidden growth opportunities within your business. For example, it may help you realize the need to create additional marketing channels to increase sales. Or, it could lead you to the conclusion that launching additional products or services to your existing customer base could dramatically increase your revenue.

On the other hand, your valuation could reveal unexpected costs within your business that could be eliminated. While this doesn’t necessarily increase your revenue, it could help your profitability.

Your business valuation could also help you recognize adjacent markets that are ripe for the picking. This could even lead you to reposition your company to be able to take advantage of the opportunity.

“The information you glean from your business valuation can help you identify hidden growth opportunities within your business.”

2. Valuation Helps to Identify Risk and Make Your Business More Stable

A thorough business valuation by an experienced professional can be a great way to identify risks within your business. Armed with this knowledge, you can then take steps to mitigate these risks. In the long run, this leads to a stabler business.

Mitigate single points of failure

Any part of your business that relies on a single point of failure incurs elevated risk. If you only sell one product or your marketing efforts rely solely on paid ads, your business could be headed to the dustbin if either takes a major hit. One ad algorithm change or one supplier mishap could be the end of your company.

The antidote to this problem is to diversify your operations so that you eliminate all single points of failure. This could include launching additional products or adding new marketing channels.

Anytime you run a business, you run the risk of encountering legal issues. This could include lawsuits from customers, suppliers, or competitors. Conversely, you may be compelled to sue other entities for a number of reasons, including patent infringement, payment issues, or contractual disputes.

While you can’t fully eliminate all legal risks, you can take steps to mitigate them. For starters, make sure your business formation paperwork and licenses are current and up to standards. At the same time, maintain accurate and legal accounting practices to stay on the good side of the IRS.

Getting your business valued can help you identify your risk of incoming legal action as well as any unprotected intellectual property that you may have. In this case, it may be best to speak with a lawyer to shore up your defenses and lower your risk of future legal troubles.

“While you can’t fully eliminate all legal risks, you can take steps to mitigate them.”

3. Learn the Unique Strengths and Weaknesses of Your Business

Business valuations are also helpful when it comes to learning about the unique strengths and weaknesses of your business. Your Advisor can bring these to your attention and help you understand what you can do to capitalize on your strengths and address your weaknesses.

Evaluate your documentation

Start by evaluating your documentation practices. As discussed before, it is highly important to maintain clear and orderly documentation for all business processes. This includes keeping professional accounting records, documenting communications with suppliers and vendors, building and updating clear standard operating procedures (SOPs), and more.

If you find any area of your business’s documentation to be lacking, work toward addressing it over time. When it comes to maintaining clear accounting records, it may be preferable to hire a professional bookkeeper.

SOPs outline all of your business processes in order to create a more streamlined and efficient operation. While it may take some time to complete them, the benefit is worth the effort. In addition to helping you run the business more effectively, clear SOPs make it much easier for a new owner to take over. This makes your business more attractive, raising your company’s value.

“The easier your business is to manage, the more transferable it is.”

Improve the transferability of your business

Not all businesses are easily transferable between owners. For starters, if your company is tied to your personality or image, how would a new owner be able to run the business once you step back from operations? While some business types are more prone to this issue than others, it is worth considering.

If your image is tied to the business, take steps to separate them over time if you think there is a chance you would want to sell your business in the future.

The easier your business is to manage, the more transferable it is. Standard operating procedures and clear documentation help make your business easier for a new owner to manage.

In addition, you may want to consider building teams or hiring individuals to run some or all aspects of your business operations. Well-functioning teams reduce your necessary time commitment to the business, freeing you up to pursue other interests or spend time with the people you love.

If you do eventually decide to sell the business, prospective buyers will find your automated business a much more attractive prospect, setting you up for a truly profitable exit. 

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