In my last article, I told you that a business’s value and its profitability are different things. If you chase quantitative profits without making changes to your qualitative assets, you will stifle your business’s growth in value. But if you’re trying to make your business more appealing to investors, customers, or buyers, what type of value should you be increasing? In this article, we will be discussing the types of value in business and which you need to be focusing on for growing the value appraisers look for in your company.
I started investing in baseball cards back in elementary school. My dad and I would go to the store each week, and I’d spend my hard-earned money to buy cards for my collection. Once we got home, we’d open up the pack of cards, and we’d look through the Beckett Pricing Guide to see if any of them were valuable. Sometimes, I’d pay a dollar for a pack of cards and find that one of the cards was worth ten dollars. Other times, I’d spend a dollar and find that I only had 50 cents worth of baseball cards in the whole stack.
No matter how valuable or worthless Beckett’s Pricing Guide said my cards were, I could always trade up for some of my buddies’ cards. Inevitably, I could trade a card worth 50 cents for a buddy’s card that was worth a dollar. My friends had the same pricing guide I had. Yet at times, they were willing to trade their more valuable cards for my less valuable cards. But why? Did Beckett’s Pricing Guide undervalue my card? Was it wrong, or did my buddy just overpay?
When you deal in the world of values, you will often find that a purchase price can be higher or lower than a guideline. Discrepancies like that happen in real estate, in the car industry, in collectible trading, and in other industries that offer commodities for sale.
To understand the mystery behind value, you have to look at the various types of value. Many times, people say they want to pay market value or fair market value for a product, but is that accurate? You see, there are several different types of value, and each type has its own price point. So ultimately, if you’re trying to increase the value of your company to make it a publicly traded company, to attract investors, or to sell it for profit, you have to understand which type of value you need to increase. Which type of value determines the price of your shares?
First, your business has a Fair Market Value, or an FMV. At its most basic, Fair Market Value is the price for which a property or business would sell on the open market. It’s the price upon which a willing buyer and a willing seller who are reasonably knowledgeable about an asset agree. Both buyer and seller are familiar with pricing guidelines and market variances, and both agree that the asset is worth x amount of dollars.
Most often, Fair Market Value is assigned to a business or its assets for tax purposes. IRS Ruling 59-60 governs FMV and determines a business’s worth in order to assess personal and property taxes on it. However, Fair Market Value can also be used to determine a business’s value if business partners or spouses who own equity in a business are separating or divorcing.
Next, your business has a Fair Value to it. Fair Value is not much different than Fair Market Value. On one hand, it’s the sales price upon which willing buyers and willing sellers agree. On the other hand, its value is often determined by the open market or the securities market (stock market) rather than the IRS.
In small businesses, accountants will often use a discounting method to determine the fair value of a piece of equipment. Additionally, accountants or trustees will use fair value to determine the price of 409A Employee Stock Option Plans.
Most commonly referred to as the Market Capitalization Rate, Market Value is determined by the current value of your business’s stocks.
In a publicly traded company, you can determine market value by multiplying the number of outstanding shares of stocks by their current price on the market. For instance, let’s say that your company has 100,000 shares of stock. Each share is priced at $20. 100,000 multiplied by 20 gives your business a Market Value of $2,000,000.
However, in a private company, Market Value is most commonly used in a business auction. It’s simply the highest value a company would receive on the open market if multiple interested parties placed bids for the business through an auction environment.
Next, we get to Investment Value, the value of an asset to a particular investor. In your business, you may have someone appraise your company and say it’s worth x amount of dollars on paper. However, a potential buyer offers you a little bit more money because it’s worth more to him or her to secure the sale. Perhaps, the buyer looks at your company and thinks he could receive a quick return on his investment. Thus, he’s willing to take a risk and pay more than the appraiser says it’s worth.
In addition to Investment Value, you have something called Strategic Value. Many times, buyers will own a business totally unrelated to yours. However, they’ll make a strategic move to buy your business because it complements theirs. They see something in your company that could grow their company. Maybe a buyer has a company that fixes water line leaks, and your company repairs roads and surfaces after he drills into them. He’s willing to pay a little bit more to acquire your company than another buyer would because it benefits his existing company.
Then, there’s the book value of your business which is simply what the balance sheet says your company is worth. While this seems relatively simple, I caution you about using it to value your company. You see, many business owners depreciate their assets and equipment in their books as a write off against their income taxes. Therefore, their companies’ balance sheets likely indicate that their assets are relatively worthless.
In addition to book value, there’s liquidation value which is what you get for your technologies and equipment if you’re trying to close your company. It’s the maximum price people would pay for your assets.
In liquidation value, you control the sale of your assets if you’re closing your company. However, in a forced liquidation, investors or banks are typically closing your company because you cannot pay your liens. In an attempt to recoup losses they’ve sustained on account of your business losses, investors will set a sales date and time to auction off your assets for the maximum amount sale attendees will pay.
Your business could also have what’s called a collateral value. Most simply, collateral value is the amount of money a lender is willing to lend you against the assets you have within your organization.
Ultimately, you can determine the worth of your business using any of the types of value listed above. And when people talk about “the value of your company,” they could be talking about any of those values.
However, you can’t directly increase or decrease any of the above values. You aren’t in control of markets, securities, or lenders. You can’t predict economic, political, or environmental changes. Therefore, if you’re trying to grow “the value” of your business, another type of value must exist.
When I talk about growing the “value” of your business, I’m referring to the only type of value you can affect – your business’s INTRINSIC VALUE – which is determined through a fundamental analysis of your business’s quantitative AND qualitative factors.
Intrinsic Value is a holistic look at your business’s capital, earnings, revenue, and profits (the quantitative) along with its management, culture, intellectual capital, etc. (the qualitative). You can drive up quantitative and qualitative factors. Actions you take can increase your income and decrease your expenses. You can hire amazing team members and create a culture of kindness. You can make business plans, marketing plans, and exit plans that revitalize your company and increase its influence within your marketplace.
Yes, you can do these types of techniques and many more to affect the intrinsic value of your company. And if you do – if you drive up the intrinsic value of your business – then you can drive up all the other values listed above.
Be sure to join me in my next article where I talk about Business Valuation Approaches used to determine your company’s intrinsic value.