Valuation Principles in Our Sector

The people at websiteclosers.com value their clients. There are a plethora of businesses out there, and with that comes business owners looking to sell.

It’s up to people like Jason and Ron at websiteclosers.com to find buyers.

But before the handshakes and signed deals are done, there’s a lot of work that’s put in beforehand. For one, not everyone and every business can be taken on as a client.

Jason and Ron break it down for us in this episode of Deal Closers – A Tech & Internet M&A Discussion.

What Is the Valuation Principle?

The search for “valuation principle definition,” “what are valuation principles,” and “what is valuation principle” is a good place to start before you sell or purchase a business because valuation – the practice of determining an economic value objectively – is a huge determinant of the sale price. 

A valuation principle is a basic finance concept that asserts that the value of an asset is determined by its potential cash flows. In other words, an asset is not solely based on its current cost or market price but rather on the anticipated benefits it will generate in the future.

Fundamental Valuation Principles

What are the principles of valuation? Business owners who plan to sell their businesses need to know how their businesses are valued.

Below are the basic business valuation principles:

• The value of a business is defined only at a specific point in time.
• The value of a business largely depends on its ability to produce future cash flow.
• The market commands the proper rate of return for acquirers.
• A business’s value can be influenced by its underlying net tangible assets.
• Value is influenced by the transferability of future cash flows.
• Value is impacted by liquidity.

Business Valuation Principles: Other Considerations

When evaluating a business, several key factors beyond revenue influence its overall value.

• Staffing costs, for example, vary based on location, with higher salaries in expensive areas reducing profitability, which impacts valuation.
   
• Similarly, competition plays a role, as businesses in less competitive markets, such as rural areas, may be more profitable despite serving smaller populations, while urban markets may face lower margins due to increased competition.
   
• Access to financial statements and corporate tax returns is essential to analyze trends in profitability and risks over time.
   
• Revenue alone doesn’t tell the full story—operational costs, market conditions, and other financial metrics are crucial in determining the true value of a business, which is why a comprehensive assessment is necessary.

Key Valuation Methods

When it comes to mergers and acquisition, there are valuation methods to determine what a company is worth. Each offers a unique perspective on its sale price. No single method is universally more accurate than the others.

• Earnings Multiplier. This approach provides a more accurate analysis of a company’s value than the times revenue method. It focuses on profits, which are seen as a stronger indicator of success than sales.
   
• Liquidation Value. This method calculates the net cash a company would receive if all its assets were sold and its debts fully paid off at present.
   
• Discounted Cash Flow (DCF) Method. The DCF method projects future cash flows and then adjusts them to determine the company’s current market value. The key distinction from the earnings multiplier method is that DCF takes inflation into account when calculating the present value of those future cash flows.
   
• Book Value. This method evaluates the worth of a business based on shareholders’ equity as detailed on its balance sheet.
   
• Times Revenue Method. This method uses a multiplier to apply to a company’s revenue stream over a specific period. The multiplier varies depending on the industry and broader economic factors. For instance, a tech company may be valued 3x its revenue.
   
• Market Capitalization. A straightforward method that’s calculated by multiplying the company’s stock price by all of its outstanding shares.

Principles of Business Valuation: Application

Company valuation principles apply to all kinds of businesses, including digital-based companies like what Website Closers is mostly dealing with. According to Jason, the first step is to determine whether the seller is offering a product and service so his team can take a look at the URL.

Financials are the next big thing they look at. The team needs to understand the current status and its history. Information provided by financial statements allows brokers to see how the business is trending and look at the business performance, including:

• How many products represent the company’s sales?
• Is there a recurrent revenue? Or a subscription revenue?
• What does the lifetime value of the company look like?

Importance of Accurate Valuation

A business owner may not have the same viewpoint as buyers in the marketplace. It’s the responsibility of the broker to bridge that gap and appraise the business objectively, which makes the seller and the buyer satisfied.

What the seller sees as “making money” is almost always subjective. Brokers guide the seller, helping them determine the difference between cash flow and profit.

Factors Affecting Business Valuation

These are just a couple of factors that affect the sale price of a company:

• Accuracy of financial records (clean records get better valuations)
   
• Responses during the interview conducted by the buyer. Website Closers helps sellers with this aspect so that they can represent their company well through the answers they relay.

Challenges in Business Valuation

Business valuation is never a straightforward process. Jason and Ron provide some examples of what makes the process of determining the market price an intricate one:

• Seller expectations:

• The sellers are eager to make a quick sale and aim to find a balance between a fair market value and the price they hope to get
  
• Others are aggressive and want to sell the company at the highest possible price
  
• Some sellers base the price on publicly traded information and question brokers why their business can’t be sold as high as what they’ve heard.
   

• The selling price can never be exact. Brokers can only go as far as providing a price range.

• Certain companies are looking for certain multiples.

• Tax returns:

• Brokers may struggle to identify which expenses business owners write off and whether they qualify as legitimate add-backs.
   

• Inventory issues.

• Several products of a company take off so fast that they run out of stock.
• The lack of inventory creates complications in projections.

Best Practices

Jason and Ron also share some of the best practices by sellers so that they can sell their company at a rate they are satisfied with.

• Since the sale price can’t be exact, brokers present both the lowest and highest possible price at which the company can be sold.

• Brokers may suggest waiting things out if the seller is aiming for a higher price.
   

• Talk to a broker who’s familiar with your industry — someone who has sold a company similar to yours.

Valuation Principle: The Bottom Line

Automated valuations cannot serve your best interests. As a seller, you need brokers who are well-versed in valuation principles and methods to also get a view of what’s fair for the market. You also need these experts to dig into your financials and company performance if you want to sell your business at the highest possible price.