In Part 1, we discussed why business valuation is important and what information is needed to get started. Now, let’s explore the methods used to value a business in Canada and the common mistakes that business owners often make during the process.
Valuation Methods
There are several approaches to determining the value of a business. The method used often depends on the type of business and the circumstances of the transaction. Here are the most common approaches:
- Income-Based Valuation
- Discounted Cash Flow (DCF): This method is used when cash flow is expected to fluctuate. It’s ideal for rapidly growing businesses, as it accounts for future earnings potential.
- Capitalization of Earnings: Used when a company’s cash flow is stable, this approach calculates the value based on current cash flow or earnings, then projects them into the future.
- Market-Based Valuation
- Comparable Transactions: This method looks at sales of similar businesses and uses those metrics to value your company.
- Public Company Comparisons: If your business can be compared to publicly traded companies, this method can provide a benchmark for valuation.
- Asset-Based Valuation
- Liquidation Value: This method calculates the value of a company’s assets minus liabilities, essentially what would be left if the business were liquidated.
- Adjusted Net Asset Value: This approach adjusts the book value of a business’s assets and liabilities to reflect their fair market value.
Common Valuation Mistakes to Avoid
Valuing a business is a complex task, and business owners often fall into several common traps:
- Unrealistic Expectations Entrepreneurs may overestimate their company’s worth, expecting higher valuations based on personal perceptions rather than objective financial data. It’s crucial to be realistic about market conditions, buyer interest, and future earnings.
- Expecting Valuation to Stay the Same Business value can fluctuate due to changing market conditions, regulatory developments, or sales trends. An outdated valuation can give you a false sense of your business's worth.
- Trying to Do It Yourself While it may be tempting to save costs by handling your own valuation, this can lead to mistakes. For example, you might apply an unsuitable valuation method, overlook important details like non-recurring expenses, or make unrealistic projections.
- Not Sharing Enough Information To get an accurate valuation, you need to be transparent. Holding back critical business information can lead to inaccurate results. Be prepared to provide all requested data to your valuator.
- Confusing Price with Value The valuation process provides an estimate of your business’s worth under fair market conditions. However, the price a buyer is willing to pay can differ. Factors such as strategic synergies, emotional investment, or deal structure can cause a buyer to offer more—or less—than the fair market value.
A business valuation is more than just a number; it’s a vital tool for making informed decisions about selling, transferring ownership, or growing your business. Whether you’re looking for a preliminary estimate or a comprehensive review, working with a professional valuation will help you avoid costly mistakes and give you confidence in your next steps.
If you’re thinking about selling or transitioning your business, a professional valuation is your first step to success. Koroll & Company, chartered professional accounts, offers a range of business services including advisory services for succession planning and business valuation. Contact us today.
