If you don't know what your business is worth, you're in the majority. Most entrepreneurs have no idea how much their businesses are worth, though they guess from time to time. "Back of the napkin" calculations are common, and most valuation claims begin with "I figure." A lack of discipline now could cost you tends of thousands of dollars later - maybe more.
Most business owners associate valuation with the sale of a business. Until you sell, you focus more on what you earn and can spend every month than you focus on how much the business is worth. But it is short-sighted to wait for a sale to begin assessing the value of your business. You make decisions every day - from investment planning to estate planning - that can impact the ultimate value of your business. Your business probably is among your most valuable assets, and not knowing its worth can lead to poor investment decisions elsewhere.
Valuing your company is like admitting your weight. There is an accepted process that leads to a disappointing conclusion, after which you rationalize your way to the answer you want. Think about it. Let's say you step on the scale and see 200 pounds as your weight. That can't be right. Well, it's 3 p.m., and you ate breakfast and lunch. That's worth a few pounds. And you're wearing clothes and really heavy shoes. The shoes are worth about 5 pounds, right? Eventually, you whittle your way to a svelte 185 pounds.
This is how most entrepreneurs value their businesses. They start with a formula, such as a percentage of gross revenue or a multiple of earning. Then, they massage the numbers, citing operational efficiency, brand strength and other intangibles. But reality strikes at the time of a sale. Just as a look at my belly tells me the truth about my weight, a buyer delivers a business owner the message about company value.
The reality of valuation in porn
In adult entertainment, a number of industries intersect. Porn may be porn, but a company will be valued based on the mainstream business model it resembles most. Whether an adult company is in content production or retail, for example, matters more than adult versus non-adult.
Two formulas make up the core of the valuation process. You choose one based on what kind of company you own. Service-oriented businesses gauge value by assigning a percentage to top-line revenue. The range is broad. Some businesses will sell for only 50 percent of annual revenue, while others may attain valuations above 100 percent of annual sales. Where a company falls on this spectrum depends on factors such as its number of repeat customers, brand strength and operational efficiency.
The other common valuation method is to use a multiple of net earning, the profit after all direct and indirect expenses. Depending on the type of business you have, the multiple used will vary. Valuing a business at twice the most recent year's net earning tends to be conservative, and the multiple can exceed seven in rare cases. This approach is most common with "product" companies, from retailers to online content businesses.
Sources at the American Institute of Certified Public Accountants strongly discourage "do it yourself" valuation. Valuation involves a considerable amount of nuance. The right multiple of earning or percentage of top-line revenue can depend on a myriad of factors, and judgment is necessary. Experience matters, and some pursue additional education and credentials specifically for valuation. Look for certified public accountants with the AICPA's Accredited in Business Valuation (ABV) credential or the American Society of Appraisers' Accredited Senior Appraiser (ASA) designation. Spend time interviewing valuation specialists, and expect to pay for quality. While some valuations can cost less than $1,000, sources at the AICPA said $5,000 is a more realistic fee.
An alternative valuation strategy
Since business valuation is more art than science, it is easy to become frustrated. The answers are never crisp, and the logic can seem alien at times. Because experience, judgment and unique circumstances can play significant roles in determining the value of a business, it is unlikely any two valuation specialists will come to the same conclusion. This isn't a result of impropriety or ineptitude. Judgment calls vary, as do the results. Without a truly standard method for determining the value of a business, this will occur.
While there is room for differences of opinion, there are some valuation specialists you will want to avoid. They may make mistakes frequently or simply lack the skills to deliver a defensible result. Every market has its share of scam artists and incompetents, and valuation is no different. The rapidly growing business-brokerage market has attracted throngs of service providers who are eager to participate in a market estimated to be worth $35 billion, according to business brokerage firm BizTrade.
The fact that effective business valuation relies heavily on judgment has led many to call for an alternative valuation method. Standardization may be difficult, but the need is salient. For decades, the need for nuance has made true consistency virtually impossible to attain. However, with a bit of digging, you will find some innovation in the valuation community, and it probably will work in your favor.
John Greco, president of BizTrade, has strong opinions on this subject. "We do everything differently," he said. Instead of using complex formulas and nebulous judgments, he prefers tangible measures. In search of a reasonable benchmark, Greco decided on the results of appraisers from the Small Business Administration. Applicants for SBA loans have to submit to appraisals of their businesses in order to determine the loan sizes for which they qualify. In Greco's mind, the resulting SBA loan reflects the value of the business. "It's hard to get more concrete than that," he said.
Using this unique approach, the resulting value may shock business owners who are accustomed to more favorable conclusions, Greco conceded, but he figures that the final sale price will be about the same. "When you start with a high valuation, negotiations take longer" he said. "In the end, you think you're selling the business for less than it's worth, and you're waiting longer than you have to." By starting with the value ascertained by SBA appraisers, negations are smoother and the sale closes much faster.
You can make a difference
Even if you plan to run your business until the day you die, you should be concerned with its value. Most owner-operators will want to sell at some point. The rare breed that plans to keep watching converted clicks at the age of 85 should be thinking about estate size and heirs. Even if you die at your desk, it still makes sense to think about the value of your company. While traditional valuation formulas and BizTrade's SBA-based method may seem inflexible, you are not powerless to change the underlying facts. There are steps you can take to positively affect the value of your business.
Sources at the AICPA suggest you start thinking about the sale of your business the day it opens. You may not plan to sell your business for 20 or 30 years, but what you do from the start can have a substantial impact on your eventual selling price. Focus on opportunities that support long-term growth. You can move to the higher end of the valuation range by increasing repeat sales, generating ongoing revenue (e.g., subscription revenue) and attracting higher-caliber clients. Having better clients - those with more disposable income - leads to higher company values.
Repeat business is gold. A prospective buyer will look at your revenue streams from repeat customers in order to gauge how little work he will have to do to maintain the status quo. While revenue in the future is never guaranteed, consistent repeats are the best indicators of future success. Also, maintaining revenue from existing customers is less expensive than attracting new spenders, which leads to higher margins.
A stable portfolio of regulars is nice, but you can't stop there. Consistent new-customer growth will increase the value of your business, as well. This will tell a prospective buyer that you have no trouble attracting new money. Today's new customer could be tomorrow's ongoing buyer. Along with customer acquisition, you should keep an eye on retention. Be able to show how many new customers stick around for a while.
If you aren't thinking about how much your business is worth, you're making a life-altering mistake. Whether an illness forces you to sell your business unexpectedly or you are interested to reducing estate taxes 40 years from now, value matters. Engage a valuation specialist periodically, and you will always have a reasonable idea of how much your most substantial asset is worth. Spending a few thousand dollars now can put much more in your pocket later.
-Tom Johansmeyer
This article initially appeared in the March 2008 edition of AVN Online magazine. To subscribe to AVn Online, visit AVNMediaNetwork.com/subscriptions/.
