Many business owners only think about the value of their company on an incident basis, i.e., when they are weighing a major transaction such as a sale, considering estate planning, installing management incentives, or going through a corporate breakup or divorce. However, this does not really take into consideration why most owners are in business to begin with — to create and build long-term value. As such, conducting a periodic valuation, that is, valuing a business every few years, can be a useful exercise when it comes to measuring a company’s past performance, where it is it currently, and where it is going in the future. Said differently, a periodic valuation provides the owner with a status report on the effectiveness of the business plan in an easy-to-understand number that can be compared with the last valuation conclusion as well as the next valuation conclusion.
We are often asked by business owners about the benefit of a periodic valuation. So we thought that it would be helpful to list some of those questions and their answers in an easy-to-digest format:
Q: Why should I value my business periodically?
A: Companies and the markets they operate and compete in are always changing. Perhaps the business has undergone a change in purpose or circumstances, i.e., the owner has decided to pursue a new market, develop and sell a new product, a product/division is experiencing significantly lower/higher operating results than expected, or there is a change (positive or negative) in the competitive landscape. There could also have been a change in the business plan that is creating additional value for the company. The impact of these factors can be quantified in a periodic valuation.
In addition, a periodic valuation can tell an owner a lot about whether or not they are managing the company in a way that puts them on track to meet their exit objectives. Valuation can be a key driver of how an owner manages their business, and as such, can help them track the effectiveness (or lack thereof) of their strategic decision-making.
Valuing the business periodically can also enable the owner to track the company’s performance based on an objective metric other than the owner’s personal compensation and benefits. More specifically, is the owner creating long-term business value that will result in a satisfying exit, or is the company being managed as a lifestyle business that the owner may not be able to sell and maintain their lifestyle? This knowledge could incentivize the owner to make decisions that are most impactful on long-term value creation, and avoid decisions that could sabotage the value of their company and their personal and business objectives for the company.
Moreover, current activity in the company’s market can directly impact its value. For example, if there is significant M & A activity in the market in which the company operates, that can immediately drive up the company’s value. Of course, the M&A cycle works both ways, which can also negatively impact a company’s value. It is important for owners to monitor such events so that the valuation takes into consideration current market conditions.
Finally, periodic (even annual) valuations are often required under corporate governance documents, so a periodic update is important from a compliance standpoint as well.
Q: Why should I care about valuing my business unless I’m going to sell it?
A: For all of the reasons mentioned above — valuing their company periodically can help owners understand how changes in their business, the market, and management style impact value. In addition, we have found that repetition helps to improve the quality of successive valuations. For example, the second valuation may be better than the first, and the third valuation may be better than the second as the appraiser is able to better correlate their understanding of the company, the various company data points, and the applicable valuation metrics. Finally, a periodic valuation is valuable information when the owner receives that unsolicited call from the “best” strategic buyer and decides to entertain those discussions. The owner is already armed with a recent valuation rather than scrambling to have one prepared or updated.
Q: How often should I have my business valued?
A: We think that every two years is a reasonable timeframe for a periodic valuation unless there is a compliance or business reason to update the valuation more frequently. Prevailing wisdom suggests that enough changes occur within a company over a two-year period that it is worth the effort to update the valuation at this frequency.
Q: How long is too long to wait between valuations?
A: Typically, we advise against waiting three years or more to update the valuation because it is almost like starting over. Like a caterpillar changing into a butterfly, companies often undergo a significant metamorphosis in a three-year timeframe. So again, we recommend updating the valuation at least every other year to have the most informed and accurate picture of the company’s value.
Q: What can I learn from periodic valuations?
A: The short answer is, a lot. Think about a periodic valuation like an occasional checkup for a company, or a measurement tool along the way, that helps ensure that all of the owner’s efforts are bearing fruit – meaning they are increasing the company’s value. A periodic valuation can help an owner answer questions such as: Is the business creating value? Is it moving down a path to help the owner achieve their goals? Conducting frequent valuations can also help the owner course correct as needed to ensure that they are on track to achieve their objectives if and when they choose to sell their company or, for that matter, undertake or plan for any action that requires an understanding of business value.
The key takeaway for owners is that valuing their business periodically is critical to help ensure that they are managing the company effectively to maximize value and, ultimately, achieve their goals, whether they intend to own it indefinitely or sell it in the near future. In either scenario, a snapshot of the value of their company at a specific point in time can tell an owner a lot about where the company has been, where it is today, and where it is headed in the future, and whether or not they are on track to meet their objectives.
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