Unless you are thinking about retirement soon, you probably do not spend much time thinking about your company’s valuation. Frankly, it doesn’t seem relevant unless you are buying or selling a company, at which point it matters…A LOT.

Most of us do have a valuation for our company in our minds or on our personal balance sheet, and it usually takes one of the following forms:

1. What I Think It Is Worth – The most dangerous method! This is just a number pulled out of a hat. It almost always rounds to a nice, even number and causes an unusually high number of businesses to be ‘worth’ exactly $1,000,000. Of course, this method is completely useless. It informs nothing, is based on little to no factual information and can put you in an alternate, unreasonable reality. If this is your method, it would be wise to adjust it immediately.
2. What My Accounting Statements Say – Sometimes, your accounting statements can be a little deceptive. The rules around accounting can differ from the actual results of your business finances and how they affect you. In general, your balance sheet will most likely not be an accurate picture of what your business is worth, despite there being some pieces of information that can inform a valuation. Owners of a business we serve were using this ‘balance sheet’ method to determine their valuation. It made them believe that they had a lot more work to do before they could think about selling or exiting their business. After a valuation expert was brought in, they now value their company at 4 times the balance sheet number, which has changed their thinking on the exit strategy for their business. It would be nice to know if this were your situation, right?
3. A Multiple of X – Revenue, EBITDA, Net Profit, take your pick. I believe this method is attractive due to its simplicity. It is easy for me to value my business if it is worth 1 times revenue, or 5 times EBITDA, but these methods can be misinformed. They do not control for all the variables of a particular business. The revenue multiple is puzzling to me. Do we really believe that a business running at a 5% profit margin and a same-size business running at a 25% profit margin would both be valued at the same number? Or would a business with millions of dollars of equipment be valued the same as a professional services business of the same size with little-to-no fixed assets? I value simplicity, but many times this goes too far if it is a general guideline or industry standard and can also grossly misinform a business owner.

Your valuation does matter a great deal, even if you aren’t buying or selling any time soon. All the above methods can misinform our decisions today. You need a proper valuation so you can make decisions about insurance coverage, catastrophe planning, retirement projections and business succession plans.

The most common decision I see misinformed is the valuation method stated in a buy-sell agreement. Many times, this method is either open-ended (up to an accountant to determine) or completely different from what is in the owner’s head. These differences can cause catastrophe in a triggering buy-sell event and carry risk, especially for a surviving spouse.

If you are still using one of the previously listed valuation methods, it is worthwhile to consider getting a real valuation done sooner rather than later. An official appraisal can carry significant cost, so if you aren’t ready for that level of analysis, at least get an informal valuation done so you have a baseline from which to work (if you need resources in this area, let us know). This will give you some peace of mind knowing that your valuation is specific to you and your business, not some generic guideline, and can help inform other planning considerations for your specific situation.

Your future self will thank you!