When business owners are looking to know and understand how much their company is worth, they often overlook small details that help to determine an accurate business valuation, such as adjustments to the valuation multiple. In our previous article, we outlined the basics of what a valuation multiple is and the factors associated with increasing or decreasing that value.
Accurately referencing rules of thumb in the industry or applying the correct metrics could change your business’ valuation — which is important when making operative changes or resolving disputes among shareholders.
Learn more about the common mistakes that business owners make when incorrectly applying the valuation multiple:
Industry Rules of Thumb
Many businesses focus on the rules of thumb in their respective industries without considering that certain factors may not apply to them – and that’s exactly what makes professional valuators different. Chartered Business Valuators (CBVs) check for the meaningful factors and ensure their accuracy to avoid understating or overstating the valuation.
Qualitative Considerations
These factors are not numerical statistics, but they provide information regarding the environment of a company. For instance:
- the location of your business may impact the level of accessibility to reach their market or suppliers:
- the work culture in your company; if employee unions exist and issues arise, prolonged negotiations and strikes during operations can occur.
- Where your business stands in the marketplace; and
- several other quantitative and qualitative factors.
Factoring these qualitative considerations into the business valuations is crucial, as these impact operations. Low accessibility to the market or suppliers, a long history of union strikes, and where your business stands in comparison to industry peers are all potential risks that can affect your company’s market share, as well as the resulting valuation.
Financing Methods
Depending on the business, the financing methods may differ between a higher reliance on internal or external financing. For example, if there is an influx of internal financing, this can indicate that your business is making enough profit to consistently reinvest in other areas of operation; whereas if you are constantly sourcing external financing, it could pose a profitability risk or a leverage advantage.
If your company uses external financing, this means that you either issue shares of equity or borrow from banks and lenders. A history of borrowing debt may speak to the lack of profitability or cash flows from your operations, and as a result, depicts a less stable business. Alternatively, a history of borrowing may have been intentional in order to lower the company’s weighted average cost of capital
Right Multiple, Wrong Metric
Day-to-day operations are unique to each company, which means that each business will have different metrics to measure success and profitability. For example, an e-commerce site may track the number of page views, while a hotel may use the amount of rooms booked as a measure of progress.
Since metrics may vary, it means that depending on the operations, these factors need to be considered in adjusting the multiple before applying the multiple to obtain a value.
Additionally what the multiple is being applied to (e.g. net earnings, EBITDA, cash flow or some other metric) will have a significant impact on the value.