Understanding Business Valuations and when they are required

Embarking on succession planning? It’s time to get savvy about the worth of your business. As a business owner in New Zealand, you’ve likely poured blood, sweat, and tears into building your enterprise. Now, as you contemplate the next chapter, be it passing the baton or selling, understanding the valuation of your business is critical. We’ve put together an insightful guide on business valuation. This guide doesn’t just skim the surface; it dives deep into valuation methods and the psychology of both buyers and sellers. So, before you take that leap, equip yourself with the knowledge to make strategic decisions that will safeguard your hard-earned legacy.

 

Motivations

It is always interesting to explore factors that motivate the buyer and the seller. However, in questions of value, the fair market value standard of value contemplates a transaction between hypothetical and informed parties. Therefore, their individual motivations do not matter.

Valuation Methods

Common methods of assessing business or share valuations are:

    Discounted cash flow
    This method uses realistic forecasts of future cash flows. This method is suitable where the future performance is likely to be significantly different from past performance, or where cash flows are expected to fluctuate substantially over time. This method of valuation is normally the primary valuation method and most other methods are derived from this.

    Capitalisation of future maintainable earnings
    This is based on a future maintainable earnings stream to which a capitalisation multiple is applied. It is suitable when valuing large or controlling interests in a company that is mature with a single growth outlook.

    Capitalisation of future dividends
    This method requires an assessment of maintainable dividends and a dividend yield appropriate for that business. It normally applies when valuing small or minority shareholdings.

    Net assets value
    This method requires all tangible assets to be valued and liabilities deducted to arrive at a net tangible assets value. This method is appropriate where a sole trader or professional practitioner is selling net assets plus goodwill, or if the assets and liabilities are already marked to market, at fair value.

    Liquidation value
    With this method, Net assets are valued and adjusted for liquidation costs, losses, and profits on realisation of stock, debtors and other assets, and tax on undistributed profits. This method is appropriate when liquidation is contemplated.

    Valuation as a step to succession

    Valuing the business is a fundamental element in the succession process.

    An early valuation reality tests a business owner’s view of the business’ value. It is not uncommon for there to be a gap between an owner’s expectations around value, and the commercial realities of what the market is prepared and likely to pay.

    This valuation expectation gap is best flushed out early in the process and sets a “stake in the ground” for the beginning of a business improvement programme.

    Developing a succession plan

    Two key questions need to be considered early on in succession planning.

    1. What needs to be done to prepare the business for succession?
    2. What can be done based on the timetable agreed?

    It may well be that the succession plan needs to be ‘fast tracked’ for whatever reason, be it health of the owner, the owner’s procrastination or sudden desire to ‘quit’ the business, or even an unanticipated approach from a competitor who expresses a keen desire to acquire the business.

    Given that we don’t always have the luxury of the ideal succession time frame in business, it’s useful to establish the key factors that you should prioritise when contemplating the sale of your business.

    Four key areas to consider when getting your business ready for sale

    There are four key areas to consider when getting your business ready for sale or the transition of ownership via succession planning. These items include:

    • Structuring
    • Housekeeping
    • Risk management
    • Value enhancement

    Time frame for the valuation process

    What you can achieve in the preparation stage primarily depends on the time frame chosen. To achieve a sustainable value difference probably requires a minimum of three years in most businesses.

    If less than a year is available to complete succession, it is likely that only housekeeping matters can be addressed.

    Priorities in a short time frame

     

      1. Complete the diagnostic analysis of financial and non-financial matters
      2. Complete an internal due diligence on business risks
      3. Take action to remove any obstacles to succession planning success
      4. Identify any surface enhancements that can be made to the business to improve its saleability and value

    Understanding the true value of your business is crucial as you embark on succession planning or consider selling it. Don’t just skim the surface; dive deep into valuation methods and the psychology of buyers and sellers. To equip yourself with the knowledge to make strategic decisions and safeguard your hard-earned legacy, reach out to DFKOGC.

    We’ll guide you through the business valuation process so that you will know the answer to the question “What is my business worth?” and help you understand what you need to do to get it ready for sale.

    Contact DFKOGC today and ensure you have the expertise and support you need.

    Book a Complimentary 1 Hour Consult

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