Valuing a business that is losing money
Valuing a company that is losing money? Businesses face a host of risks every day. But sometimes truly epic economic shifts occur.
Whether a financial markets debacle or natural disaster, their effect on the economy and business fortunes may hit abruptly and have profound effects. Once high flying companies could face the headwinds that business owners cannot foresee.
So if a company swings from being profitable to losing money, how does it affect its business value?
The three ways to figure out your business value
Ask a professional business appraiser about how to value a business. And you will hear about the three ways or approaches to measuring the business worth:
- Market – relies on comparison to similar business sales.
- Asset – which looks at the values of business assets and liabilities.
- Income – where you determine business value based on its income and risk.
And you can value any business using these approaches. Moreover, you can do it regardless of the company’s current financial performance.
Put differently, a business may be bleeding red ink at the moment. But it may still have considerable economic value and command quite a bit of money.
Business value depends on the long-term earnings outlook
Remember that all business valuations look into the future. In other words, your business value depends on the future business prospects. And business people can do quite a lot to increase their business worth. For example:
Business owners may decide to merge businesses that lose money. The combined company could enjoy advantages that drive profitability: better product bundling, access to new markets, lower costs due to economies of scale from better integrated operations, and much more.
A business can attract smart investors that bring not just money but considerable managerial skills to the table. This may help the company develop new products and services, enter new markets, and turn its technology and know-how to profitable use.
Over time, the company owners may introduce operational changes that cut costs and improve efficiency. Long-term employees are often an excellent source of ideas to maximize profits and how to implement them to contribute to the bottom line.
Putting the business up for sale
Of course, the company owners may decide to sell the business. Can an unprofitable business sell? Yes – provided you can find the right type of business buyer. Some typical types:
Financial business buyers
Typically savvy investors that focus on low-cost income streams. They tend to look for low-debt, highly profitable companies. These market participants often focus on the so-called cash cows, businesses that tend to generate steady income year after year.
Synergistic business buyers
These may be a group of investors or a larger company looking to grow through acquisitions. Such buyers may well be interested in the acquired company’s longer-term potential beyond its immediate profit numbers. Think leading edge intellectual property (IP), skilled and motivated staff, exclusive agreements with key customers or suppliers.
Business valuation models and methods for unprofitable businesses
Market comparisons to similar established companies are an excellent way to estimate what your business is worth. You have quite a choice of standard valuation multiples that relate the business potential selling price to its financial fundamentals.
Valuation multiple choices that work well
For an unprofitable company, the following valuation multiples are especially useful:
- Business selling price to gross revenues or net sales.
- Selling price to business assets, such as total assets or tangible assets.
- Price to book or market value of business equity.
Plan to re-capitalize the business or sell it to a well-funded buyer? Then consider the valuation multiples based on business revenues or assets. Selling price to total assets is a really good fit for valuing a business that has both tangible and intangible assets. For example, your company may have intellectual property, customer lists, valuable distribution rights, and the like. Think valuation of a high-tech start-up that hasn’t turned a profit yet.
The valuation multiples based on profitability, such as discretionary cash flow, EBITDA, or net income, will likely paint an unfavorable picture of what the business is worth.
Business valuation based on future income
Income based business valuation methods, such as the Discounted Cash Flow, are very well suited for valuing a business that currently runs at a loss.
This well-known method lets you calculate business value based on the company’s earnings forecast and risk assessment. Typical forecasts are done for 5 years, followed by the estimate of the business’s long-term terminal value.
Asset based business valuation methods
You can also use asset business valuation methods, such as asset accumulation or capitalized excess earnings. A well-established company may command considerable goodwill, despite the current slide in profitability. To calculate business goodwill, you will need to use the earnings estimate that represents the long-term business earning potential.
Your business valuation model may include a number of methods to determine what the business is worth. This multi-faceted approach is typical of professionally done business appraisals and tends to produce accurate, defensible results.
Take a look at the sample business appraisal report to see how the results of different valuation methods are consolidated into a comprehensive conclusion of business value.