By CA Ayush Parakh:
We’re often asked the question “Why do promoters need a valuation, especially if they have no intention of selling their business any time soon.?” We always respond that knowing the baseline value of business is the starting point for promoters who want to effectively build a company with transferable value. Quite simply, valuations can be instrumental when it comes to accomplishing promoter’s objectives, and knowing the value of business (throughout its life cycle) can be a helpful and effective management tool. Following, we’ll explain several reasons why valuations are essential. 1. Valuations provide a baseline: Just like getting an annual physical at the doctor’s office, regular valuations provide a baseline.
They serve as an indication of what the company’s doing right and what it could be doing better. Some years its value may be up, other years it may be down a little bit (particularly in the event of a market correction). But without knowing the company’s baseline, promoters have no solid evidence of how the company is doing. Think of a valuation as a health metric for the company that serves to measure the company’s blood pressure.
2. Valuations help chart the course for the future: Simply put, the company doesn’t know where to go if it doesn’t know where it is. Valuations can help the company/promoters determine ways to improve the business. Perhaps a valuation will indicate the need for a technology investment or hiring an employee.
3. Valuations measure progress: Performed regularly, valuations provide a pretty good measure of how the company is doing compared to the path it has set for its business. To be most effective, valuations should be utilised in tandem with company’s strategic business plan and should be referred to as a component of any significant decision.
4. Valuations can identify gaps: A comprehensive valuation will utilise key performance indicators (KPIs) to look at the non-financial aspects of a business that are actually the underlying value drivers. Examples are corporate structure, client demographics, technology usage, and firm infrastructure.
5. Valuations help promoters manage their business: The purpose of a valuation is to track the effectiveness of the promoter’s strategic decision-making process and provide the ability to track performance in terms of estimated change in value, not just in revenue. This helps them to take a holistic look at their business and make decisions that are highly impactful for their bottomline.
6. Valuations create accountability: Now that the company has utilised a valuation to identify gaps and set a path for the future (with measurable goals), it has, in essence, made itself accountable for achieving those goals and can create discipline around them. Remember, this should be used as a component of its strategic business plan – because if the company can measure it, the company can manage it.
7. Valuations provide a benchmark: With little to no public data available on what businesses in concerned industry sell for (the vast majority of deals are never published), knowing the company’s baseline value can allow it to benchmark itself (via KPIs) against its peers, as well as ‘best practices’ standards.
8. Valuations provide a perspective on price: When it comes to transition, the company’s historical valuations (remember, valuations should be an ongoing exercise) provide a starting point for price. Whether it’s an external sale or internal next-generational transfer, the company now has an idea of what its business could be worth to a prospective buyer (though price is only one component of a deal).
9. Valuations can provide the gateway to capital: If company is considering borrowing capital for an acquisition or other business investment, any lender will want to know what leverage lies in its business. Company’s valuation is the first step in the process of securing capital.
10. Valuations are part of a promoter’s estate plan: For a promoter, the business value typically represents 50-70% of their personal net worth. More often than not, promoters fail to diversify the concentrated stock position they hold in their own business. Knowing how the business value impacts their personal financials can help them better plan for their family’s future. Unquestionably, valuations serve many purposes and go well beyond “what someone would pay for the company’s business.” Used properly, valuations allow the company to see the inner-workings of what’s really going on in its business. (The author is Valuation Head at Kreo Capital Private Limited and can be reached on [email protected])