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Hey, do you know that business owners leave money on the table on over 90% of all transactions of businesses sold in the US every year? So that means that only 10% of business owners who are selling their business get full price. That’s not good. But the good news is that in today’s video I will talk to you about the top three forms of valuations and why an asset-based valuation is the worst thing for your business. So don’t fall for that.
Hey, everybody. Welcome to 7 Figures & Beyond. I am your host, Leo Landaverde. I am an author, business coach, and CFO to small business owners, and I am passionate about helping business owners scale quickly and efficiently, maximize profits, and maximize the value of their business so they can eventually sell for millions. Let’s do this.
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So there are basically three major types of business valuations, and they are right here. So number one it’s asset based, number two is earning value, and number three is market value. But today we’re only going to be talking about the asset-based valuation. So there are two types of asset-based valuations. One is the book value, and the other one is the liquidation asset based. So let’s talk about this one first.
The liquidation asset based is when, what is the worst thing that can happen? And that is the first thing that a bank looks at to estimate the life of the company should the worst happen, which is current assets minus current liabilities. So that presupposes we know what current assets and current liabilities are. So in a liquidation, asset-based is worst case scenario, we’re going to take all of the assets, the current assets of the company. Those are assets that can be cash or cash equivalents or can be turned into cash right away. And it’s typically everything that can up to 12 months, minus the current liabilities, are all those liabilities, all those monies or that short-term debt that you have that is due within 12 months.
So if you were to take your current assets and you take away or remove, subtract the current liabilities, what we’ll give you is a liquidation asset based. Technically, the worst thing that can happen to you, and that means you’re going out of business, you’re not selling your business. Okay, so book value within the asset-based category, we have two types of asset-based valuation.
We already talked about liquidation asset-based, we’re going to talk about book value now. But before we talk about book value, we have to understand the balance sheet. So the balance sheet is your assets equals liabilities plus equity. Now there are three major financial statements that you should be looking at as a business owner every month and they are your profit and loss that tells you about your revenues, your gross profit, your net profit. And then you have your balance sheet, which is a permanent record of your assets, liabilities and equity, and you have your statement of cash flows. That is the gap in between.
So for the purposes of this video we are talking about book value of your assets. But what are your assets? So your assets come in many ways in many forms. So you have your cash, your money market accounts, you have your A/R, you have your prepaid, some prepaid expenses might be short-term assets. Say you prepaid rent for six months in is sitting as a current asset in your books. That’s part of your assets. Now there could be other assets. We have current assets and long-term assets. You may have equipment that you have purchased that you’re currently depreciating in your business. That is part of your assets. It’s something that belongs to the company that has value, book value.
Now there may be some depreciation involved, but the point is this stuff that actually makes you money and assets you’d be making your money. Anyway, so if somebody was to evaluate your business based on the assets, of course they’re going to take into account your cash and cash equivalents, and they’re going to look at your A/R. Now as a rule of thumb, any accounts receivable over 90 days in age will be discounted because the chances of collecting A/R, accounts receivable, over 90 days decreases dramatically after 90 days. So you don’t want to have your accounts receivable out beyond 90 days. Okay, and then you got your accounts receivable we talked about in assets. Now here is the problem with an asset-based valuation. It takes into consideration today. It has no mention of the future. It does not account for the future.
The future does not exist in an asset-based valuation. And here’s what else is not included. Well, you’ve got your future worth. You’ve got your trademarks, your intellectual property, and your trade secrets. Let’s go one by one. Your future worth. Well your future worth comes from where you’re going, right? Every time I get engaged and start working with a company, I want to know where they’ve been before I can prescribe where they’re going. So if you’ve been growing at a rate of 10% year over year for the last three years, that valuation will be lower under an earnings valuation than if you’re growing at a rate of 30% year over year. You’re a faster rate of growth. That means a higher valuation. So the future growth really depends on your trending. Data, it’s only useful as you can compares to other data.
So when I do start working with a client, the first thing we do is we look back three years before we can look forward three years. I want to know where you’ve been before I know where you’re going. And the quickest way to maximize the value your business is by accelerating growth. But if you have a model that works for business, if you have a profit model, we throw gas on it by marketing, which means that you know that you’re making money. We just need to acquire more customers so we can have a faster rate of growth, which means that it’s going to mean a high valuation. But that’s a topic for another video.
Trademarks, number two. That’s brand equity, by the way. You should be legally protecting any trademarks with a US patent and trademark office. For that I’d recommend that you don’t do it on your own, you actually hire an attorney and a competent person who is going to ensure that your trademarks are properly protected.
Your intellectual property. Do you have anything that you’re doing in the business that’s something unique, your secret sauce? You created your own piece of software, even though you don’t sell it to the public, it allows you to run your business very efficiently. And say if you’re in a very niche industry, well that type of process and that type of software that you use, that you built for yourself, could be worth millions to the right buyer who is trying to acquire and ramp up your industry. So you should protect your intellectual property. I strongly encourage you to have a very good transactional lawyer and a patent lawyer if you’re actually growing and you have intellectual property, you want to protect.
Trade secrets. Is there anything that you do that is proprietary, that is unique? Now, here’s advice that I give to all employers. Every time a new employee joins your organization, you want to make sure that you are securing all of your trade secrets from the get-go, letting them know your potential employees, or your new employees, know that if they’re actually take any of your trade secrets away, there’s going to be a penalty for that because it doesn’t belong to them. That’s a video for another day. Trade secrets. So that’s why I say at the outset that asset-based valuation is the worst thing for your business because it doesn’t take into account the future growth, trademarks, intellectual property, and trade secrets. So take this to heart. So, there you go.
Hey, by the way, thank you so much for watching this video. If you found this video useful, it would encourage me, if you comment below and like the video and comment, let me know if you ever have your business appraised. Because it’s very important to have your business appraised every so often so you know exactly what you need to do to grow it and what a baseline valuation is.
For a short period of time, I am giving away my Income Approach to Valuation workbook, which I highly recommend. It leads to much higher valuations, which is the goal. This is my gift to you. Feel free to download it by clicking on the link below this video. Also, if you want to join a community of like-minded, successful entrepreneurs, just like you, then join our Facebook Group at the link below where I share tips, tactics, and strategies on how my clients are growing their businesses to 7 Figures & Beyond.
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