Buying a business is one of the most rewarding and risky ventures you can undertake. Is it a springboard to success or a nightmare waiting to unravel? That depends on how well you prepare and what team you select to support you. Knowing how to value a business for sale can reduce a significant amount of risk when it comes time to decide.
CFOshare Business Valuation Methods
CFOshare can help you make informed decisions when valuing a business for purchase. Get in touch with one of our experts today to leverage our business valuation methods and expertise.
Business Valuation Methods
Valuing a private business for purchase is a highly technical task. It is not an exact science, so the best valuation is performed at least 3 different ways. Typically, this would be:
A Technical Analysis
Diving into detailed financials, picking apart earnings, and projecting ongoing returns.
A Market Analysis
Reviewing comparable transactions, calculating averages, and establishing a fair valuation region.
A Worst-case Analysis
Valuing the business for purchase’s assets and liabilities to understand liquidation value
These methods are similar to valuing a stock, but private company valuations are challenging: financials are more opaque, there’s less market data to draw from, and risks are significantly higher. Therefore, private company valuations should not be performed by amateurs.
Undervaluing a business can result in passing on an opportunity to buy a great business. Overvaluing a business can result in paying too much, struggling to service your debt, and running out of cash. Knowing how to value a business for sale is an essential step to any successful acquisition. As a result, all three of these valuations should be performed by experienced financial professionals with access to rich transaction data.
Creating a pro forma
A pro forma is a special financial forecast to estimate how a business will perform over the next 3-5 years. While evaluating how to value a business for sale, a pro forma model answers questions like:
How much money will the business make?
How quickly can the business grow?
How much capital do I need to invest to make it grow?
You may decide to walk away from a deal if the pro forma shows trouble down the road unveiled during the private company valuation.
Acquiring funding through debt or equity
Paying for the acquisition is a challenge for most buyers. Do you raise investor funds? Do you get a loan from a bank? Do you self-fund the purchase? The answer is different for every business acquisition. CFOshare uses the pro forma process to create a capital plan, which shows the best funding path for a buyout.
Business valuation models are different for banks, investors, and yourself. Understanding financial risks, investor valuations, and lender valuations will make your pitch more effective, saving you time when seeking funding. This is key to avoid losing the deal simply because you couldn’t get financing.
Acquisition due diligence is a professional appraisal of the risks and representations of a company for sale. The list of these risks is long, but here’s a partial list of questions answered by due diligence:
- Is there anything misleading about the financials presented by the company?
- Is there a chance they will lose large customers soon?
- Does the business have liabilities not listed on the balance sheet?
- Has the business properly accounted for its inventory, equipment, buildings, and other assets?
- Are there outstanding tax liabilities?
- Are there any debt or equity holders who could halt the sale of the company?
Finding something bad in due diligence does not mean the purchase is cancelled. Often it involves a renegotiation of the purchase price, resulting in a benefit for the buyer.
A good due diligence team includes a financial professional and a lawyer. This ensures thoroughness and avoids emotional bias from the buyer.