Top 10 Reasons to Value Your Business and Know its Worth

September 24, 2016

Top 10 Reasons to Value Your Business and Know its Worth

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Knowing the estimated value of your company is a million dollar question. Not exactly a million dollars, but the estimation will definitely cost you a good amount of money. So why is a simple price tag so important for a company? In this section, we will take a look at the various reasons of how startup valuation can help your business. So let’s get started on the advantages of valuation of a company.

Reasons to Value Your Business:

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1.    Gifts

Do you know you can gift up to Rs 50,000 (evaluated in 2014) to any person per year? These gifts do not have any taxes attached to them; only gifts valued more than this specific amount are taxed. Looking at a broader scenario, these gifts could be camouflaged while redirecting stocks or equity to an unincorporated company. So how will you understand if the gift is below the value of the appraisal of the company? This is one of the reasons why entrepreneurs value their business so that they can have a small section of their value gifted for ulterior reasons and evade taxes. This is the importance of valuation.

2.    Percentage Ownership with Investors

So let’s say that investors are intrigued with your product and want to invest. How do they know what percentage of the company they get for the amount they have invested? Appraisals will help them get a detailed idea of the amount they need to invest to get a certain percentage of your company. Certain key metrics can be used for estimating the approximate value of your company, but the value of the firm tags your company with a fixed amount.

3.    ESOP

Employee Stock Ownership Plan is a partnership between the employee and the company which makes the employee a part of the company. While publicly traded companies can refer to their market value to analyse the percentage of equity of the employees, private companies need to have a figure like business worth in place to understand this. This allows them to compute the percentage that needs to be deducted from the employee’s salary to make them a part of the team.

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4.    Charitable Donations

Charity comes under the CSR of each company, and you can use your business to help these charities. It is not mandatory to be a public corporation to do this. Legality affirms that an appraisal needs to be in order, to carry out a tax exemption for less than rupees 25,000 for your company. Over the years, many businesses in India have lost this privilege because they didn’t value their firm. Such small intentional or unintentional accidents can cause your firm to bleed money.

5.    Divorce

Divorces end bad and can affect the health of your company. The law permits for equal distribution of the company’s assets if you live in a community property state, whereas if you stay in a non-community state, the percentage of distribution will depend on the appraisal of your company and the amount agreed in court.

6.    Litigation

There are times when your company can be sued on different grounds. If litigation ensues, you will need a price to your company to raise funds or sell equity. An appraisal will allow you to make quicker and accurate decisions regarding the future of your enterprise.

7.    Selling your Business

Selling your business can be a decision you would have to make either willingly or forcefully. So how much do you value your business when you are selling? An appraisal will help you make an informed decision while selling. Although the current market price would be evaluated depending on the value of the dollar, inflation, and other aspects, an appraisal will help justify your selling price.

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8.    Estate Planning

With a business running in the background, it is difficult to circumnavigate the taxation on real estate. Depending on the valuation of your business along with the valuation of property, a strategic decision needs to be made with the help of tax professionals to reduce the taxation on your real estate. Even if the gross valuation is less than the tax exemption amount, the laws in every state are different, which can be a concern. It is thus advised to get an appraisal done before you venture into purchasing real estate.

9.    Post-Mortem Planning

In case you are a partner in a business and need to do future planning as to who owns your interest in the event of your death, a buy-sell agreement needs to be carried out which defines the new owner, the shares they acquired, and at what rate they acquire them. At this point asset valuation is also carried out to determine the value of assets to be transferred to the heir. The buy-sell agreement is built on a formula which takes into consideration the value of the company which determines the amount of interest the heir gets. Other buy-sell agreements depend on the appraisal at the time of death.

10. It is Important

Does it mean that you need to get a corporate valuation due to the reasons mentioned above? No, those are not the sole reasons to get an appraisal. It is only after an amount is attached to a product that there is value to it. Similarly, appraisals allow the company founders and board of members to create strategic plans based on this value. The plan of action can be different depending on the value the company is perched on currently. One of the most important points that pops up is whether a company needs time to grow, expand, stall, or sell, which strongly depends on the current appraisal.

These are some of the advantages of valuing a company. Now that we have taken a look at the reasons why you need to create an appraisal for a company, let us take a look at how to choose a business valuation service.

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·       Professional Credentials

The business valuation firm needs to have certain credentials before they established their firm. Some of the professional credentials are:

  1. Accredited Senior Appraiser (ASA)
  2. Accredited in Business Evaluation (ABV)
  3. Certified Business Appraiser (CBA)
  4. Certified Valuation Analyst (CVA)
  5. Chartered Financial Analyst (CFA)
  6. Chartered Business Valuator (CBV)

·       Experience

A 5-year time-in-grade is the estimated time to get an appraiser credential from any of the associations mentioned above, but it is the experience that counts when you finally choose an appraiser. A long time appraiser is familiar with many complexities, which can help your company in subtle ways. The million dollar question of “WHY should we hire you for our firm?” is answered decisively by the experience of the small business valuation firm.

Determining the Valuation:

So who decides what the startup is worth? Is the figure presented by you or investors? The valuation of your company depends on the investors. If they feel the company is valued at X but you feel differently, you would still have to settle at X since that is what the investors feel. This “feel” is of course not intuitive but an estimation of the tangible and intangible aspects.

Let us take a look at the various methods to value your company.

  1. Asset Approach
  • Valuation of tangible assets of the company.
  • An empirical form of calculating the value of the company but does not define any exact value.
  • Applied for companies who are declining or those who have matured.

Types of Asset Approaches:

  • Book Value Method- Based on the balance sheet of the acquired assets and liabilities
  • Replacement cost method- Replicating the valuation for a similar business
  • Liquidation Value Method- Based on the assets owned by the company
  1. Income approach

This approach allows the investors to value the company depending on the revenue model of the company and how much they expect to earn from it in the future.

  1. Discounted Cash Flow Method

The approach is similar to the Income Approach but differs from the fact that the investors are interested in the free cash flow after taking into account the deductions like working capital, expenditure, operating expenses, etc.

  1. Capitalization of Earning Method

The expected earnings of the business will be divided by a capitalization rate which determines how much the company is worth.

  1. Market Based

Similar existing models will be compared with the same market span which will dictate the value of the company.

  1. Market Value

This is one of the most common modes of valuating the company. The investors will not subject your company to asset valuation for this process and will only check the value of the stocks in the market since they feel that the market stocks is dictating the plausibility of the venture. Higher stocks will boost your value and vice versa.

Valuing your business can take weeks which involves looking into the financial assets and structure of the company. This gives a reason for complaint by small businesses, and hence they dither from getting an evaluation. However, it is of utmost importance to get an appraisal to help boost your company and device new strategies to cope with your business. You can uncover a lot of information after creating a detailed analysis of your company.

If time is a problem for you, you can take help of online valuation consultants for helping you appraise your business.

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