Understanding the value of your Business: Part 3

19 August 2020

In the final instalment of her three-part article series, our Valuations Lead Partner Nicole Vignaroli, unpacks the key areas that are often overlooked and/or misunderstood when considering your business’ value.

Determining an accurate valuation for your business is complex and critical issues can often be overlooked by business owners (or their non-valuation qualified adviser or accountant) attempting to determine the valuation of the business.

The failure to fully understand and incorporate all aspects of an appropriate valuation can result in significant variation to a reasonable range of the underlying market value of an entity. So, it pays to partner with a valuation expert who understands rigorous and independent valuations are essential prerequisites for sound business decisions.

Picking up where we left off in the last article, here are three further areas for consideration when it comes to accurately valuing your business.

1. Discount for lack of marketability

It is common for business owners to omit the application of a discount for lack of marketability when determining the equity value of an entity.

Marketability refers to the ease and timeframe under which an asset can be sold. Assets with a greater relative degree of marketability (those that can be sold more easily, or more quickly), are inherently more valuable as it is easier for the owners to realise the value of those assets. In recognition of this, it is common practice to apply a value discount where a lack of marketability exists.

Empirical research and academic studies indicate that discounts for lack of marketability in Australia typically range between 10% and 30%. Notwithstanding, the relevant discount will vary dependent upon the specific circumstances. Consideration should be made for items such as the level of business assets that contribute to the ungeared equity value of the business on a controlling basis and the stage of the business life cycle and how that may impact a prospective buyer.

2. Value at a point in time

Valuations are undertaken at a point in time and can diminish in relevance over time. An accurate reflection of the value of an entity at a specific point in time should be analysed at the required valuation date. In addition, significant changes in the business and/or industry in which it operates can have material impact on the valuation of an entity. Therefore, any valuation analysis performed previously should be revisited in light of any internal or external developments to ensure that valuation outcomes are reasonable.

3. Loans to Directors and related parties

It is common to identify loan balances on the financial position of an entity that extend between directors and/or related parties. These balances need to be scrutinised and a determination made as to whether the amount represents working capital or funding for the business. Once the distinction is made, the balances can be appropriately incorporated into the valuation analysis, but should not be overlooked, as they typically have material impact to the equity valuation outcomes.

To recap, some of the key areas that are often overlooked and/or misunderstood when considering your business’ value were covered in the first and second articles in this series and include:

1. Normalisation adjustments.

2. Profitability and scalability.

3. Forecasting error and budgeting convention.

4. Dependency on key customers and markets.

5. Key person risk.

6. Applicable earnings multiples.

7. Surplus assets.

8. Discount for lack of marketability.

9. Value at a point in time.

10. Loans to directors and related parties.

Through start-up, expansion and continued progress, the Corporate Finance team at Findex support small and medium enterprises of all shapes by applying professional care and a wealth of experience.

Our skilled team has extensive valuation experience across a wide range of sectors and can provide valuation advice that helps provide comfort in ensuring accurate valuation outcomes. Get in touch with the Corporate Finance team today for more information on how we can tailor a solution to suit your needs.