8 Factors That Can Impact Business Valuation

If you’re considering selling your business or are looking to raise capital for your business, you will need to have your business valued and be conscious of what that entails. Even if you hire a professional to handle the valuation, you still should understand how to value your business and the factors that will impact how your business is valued. Here are some factors that can impact the numbers in your business valuation.

1. Your Earnings History

Naturally, investors or potential buyers want to know that your business has a stable history of revenues, particularly over the past three to five years. In the valuation process, you'll have to provide financial statements like your company's balance sheet and profit and loss statements.

If any extenuating circumstances caused a decline in your revenues over time (such as a global pandemic, perhaps?), be prepared to explain this discrepancy since they may be an anomaly in an otherwise solid history of revenues and profitability.

2. Potential Growth

If your company is on the new side, you may not have a long history of revenue growth. In that case, you'll need to demonstrate your business's potential growth. Are there rising trends that will likely send you a flood of new customers in the coming months? Have competitors dropped away, leaving more market share for your business? 

If you’re seeking investors, consider how the funds you’re looking for could increase growth potential even more. Maybe you want to use some of that money to hire more sales reps, who will then expand your footprint and, thereby, sales. This is important to consider in the valuation process. 

3. The Economy

Even the most successful company will be impacted by economic conditions, which may affect your business valuation. If the economy is in a slump, your business may have a lower valuation, so consider whether this is the ideal time to seek a valuation and/or sell or find investors based on economic conditions. 

4. Demand in the Market

Naturally, investors want to know that there are plenty of people who want to buy what you’re selling. If you are in an oversaturated market, there may not be as much potential for growth, and your business may be valued lower than if it were in a market with plenty of demand.

5. Your Customer Base

Who your customers are, their buying behavior, and how loyal they are to your brand all impact your business’s ability to sell repeatedly. A company that sells software subscriptions will automatically have repeat business each month, whereas a company selling mattresses likely only sells one or two mattresses to customers over several years.

The size of your customer base also matters. If your business relies on just a handful of customers for the bulk of your revenues, there is always the risk that if those clients leave, you will lose a substantial portion of your revenues. This also impacts your business valuation.

6. Your Business Location

Where your company is located may also impact its valuation. If, for example, you own a hotel in a thriving tourist town, it may have a higher valuation than the same hotel located in a town off the beaten path. If your business relies on foot traffic, you’ll also want to be somewhere that has easy parking and high visibility.

Location, too, has to do with how many competitors are in your area. If there are a dozen hotels within a few blocks of yours, you’ll have a harder time attracting customers without substantial marketing and/or dropping your price. 

7. Competitive Advantages

What makes your company unique? What makes it stand out in a sea of competitors? This is your competitive advantage, and it’s another factor that can impact your business valuation. 

Your competitive advantages could be things like having a solution that doesn’t exist elsewhere, the quality of your products, or unique intellectual property. It could also be your outstanding customer service or knowledgeable staff. The stronger the competitive advantages, the stronger the foothold you’ll have in the market, and this is a win for your business and its valuation.

8. Debt

Many businesses have debt, and that in and of itself isn’t a negative thing, but it may impact your business valuation. If your business has a sizeable amount of debt, investors may want a greater return on their investment because there is more risk. You will have to pay back a loan before the investors see any profit, and for that reason, your business may be less appealing as an investment if your debt is high.

Why Valuation Matters

Whether you're looking for investors so you can take your business to the next level or you’re interested in selling it, you’ll need to have a number that represents what your business is worth.

For investors, this business valuation will determine their percentage of ownership. For example, if an investor provides $100,000 in capital and the business is valued at $1 million, then the investor has 9% equity in the business. If the same business was valued at $1.5 million, the investor’s equity would be only 6%. The investor has to decide whether he can accept the percentage of equity.

The valuation represents expected future profits, and this is important for potential buyers. A buyer, knowing that the likelihood of seeing $X in revenues for the foreseeable future can decide whether your selling price is a good value. If the selling price is high, the buyer might not be able to recuperate the investment for many years. If the selling price is low, he’ll quickly earn back what he invested. Having your business valued can also help you, as the seller, determine what the ideal selling price should be.

Naturally, there are no guarantees for either investors or buyers, but having a business valuation as part of the negotiation process can provide insight into the level of risk that they would take if investing/buying your business.

How to Get a Business Valuation

While you may be able to do a “back of napkin” calculation to determine a general valuation for your business, you’ll likely want to have a professional business valuation expert step in. She will review your financial statements, tax returns, revenue history, customer base, business model, and other aspects of your business to calculate its value.

If you’re working with a potential investor, he may have his own expert he wants to bring in. 

What to Do if You Don’t Like Your Valuation

So what happens if you aren’t happy with the numbers? Start by having a conversation with your valuation expert to understand how she came up with the valuation. If you built your business from the ground up, you might have an emotional attachment that causes you to believe the business is worth more, but since this person values businesses for a living, she can better explain why the numbers are what they are.

You can get a “second opinion,” but consider whether the effort will be worth it to have the numbers increase just a little.

Keep in mind that investors and potential buyers have a different perspective of your business (including its risks) than you do, so you’ll need to see the numbers from their side.

Valuations can change over time, especially when you take the factors above into consideration. If the valuation is low, consider postponing the sale or pitch for investors until you can create an increase in that valuation. To achieve this, you could work on increasing your customer base and sales or wait until economic conditions improve.

Knowing your business valuation is the first step to selling your business or finding the right investors who can help you boost your business’ growth.