The ultimate indicator of how well a small business is performing is how much the company is worth. Any benchmarking system should include fair market value as one of its primary metrics. With public companies, it’s easy to monitor this metric by tracking share prices and market capitalizations on public stock exchanges. And while it’s not that simple for private companies, it’s just as important. Fair market value can be measured in two ways:

1. From an internal perspective, showing if the company is worth more now than it was in the past.

2. An external view, which compares the business’ value to other companies or industry composites.

It’s best to measure performance using both views. The internal growth in value is usually measured using dollar amount increases. External performance can be measured by selecting a valuation multiple from a comparable company and comparing it to the same multiple from your company.

Problems

There are some practical problems with using business value as a benchmark for small companies. For example:

• The opinion of an objective business valuation professional is the best and most accurate way to get the fair market value, but it could cost a lot.
• “Quick and dirty” valuation methods, such as industry rules of thumb or standard formulas, don’t consider factors specific to your company, and may not be based on current market data. This can lead to improper conclusions.
• Market value of other comparable private companies may not be available, and you may end up having to compare your company with company that is not very similar.

Solutions

If using a professional to obtain a business valuation, consider requesting something less than a full-scope valuation. A calculation of value may cost less because it is more limited in scope and usually isn’t accompanied by a formal written appraisal.

Another way to keep the cost down is to only get a valuation every three to five years. In between formal valuations, you may be able to apply historical pricing multiples to your current EBITDA to estimate value for internal purposes, if market conditions, performance and risk factors have remained pretty much the same.

It’s important to remember that past valuations may have limitations. Market conditions or the business’ financial performance may have changed to such an extent that the valuation would be invalid.

Bottom Line

The fair market value of your company provides insight into its risks and returns. But measuring value can be complicated for private businesses. Although rules of thumb and other forms of do-it-yourself appraisals may seem like an easy way to save money, they can be misleading. Contact Filler & Associates to discuss the most cost-effective and reliable approach.