If you’re planning to sell your business, an accurate valuation will ensure that all the hard work you’ve put into it will be taken into account and included in the price. Business valuations are also important when seeking investment capital, taking on a partner, or selling shares.
While many business owners have an idea of what their business is worth, that idea can quickly wither in the face of challenges from the IRS or other sources. Therefore, getting an accurate business valuation is crucial.
There is more than one type of valuation. For example, there’s no point in evaluating a services business based on the value of its physical assets. Other methods to consider include intangibles such as goodwill, which can be difficult to assess. And value may also vary with context and subjectivity — a business may be worth different amounts to different people, depending on their preferences and needs.
This means that if you want a meaningful valuation, you will need to discuss your business circumstances with a business valuation expert. You may find that the valuation expert needs to use a number of different methods and then come up with a final amount that gives weight to each figure that emerged from each method. Good interpretation and judgment will be needed to come up with a final figure that accurately reflects the value of your business.
A number of different factors need to be taken into account to ensure that a valuation is accurate and useful. Some of these factors include:
— The nature and history of the business
— General economic outlook, including industries that affect your business
— Your business’s book value, financial condition, and earning capacity
— Your business’s dividend history and paying capacity
— Investor risk inherent to your industry
— The maturity of the business and its industry
— The value of the business in the absence of the current owner
— Stock sales
— Stock of comparable public corporations
A valuation expert will also review and analyze recent financial history, financial projections, buy-sell agreements, executive compensation, organizational charts, quality of employees, management depth, major customers and competitors, and the viability of the business without the current ownership.
Methods of valuation
The crudest valuation method is known as the “multiples” method, which operates by rules of thumb. For example, legal firms are commonly valued at 40 to 100 percent of their annual fees, while landscape businesses are estimated at 1.5 times their discretionary earnings, plus the value of their capital assets. However, multiples only give a rough, industry-wide ballpark figure for business value, not an exact value.
More accurate methods include the “balance sheet” approach, which basically subtracts business liabilities from assets. The “adjusted book value” method is similar, but uses current market value rather than purchase price or depreciated value.
Retail and manufacturing businesses are often assessed according to asset value, assuming those assets are significant. Service companies are often valued using the “capitalization of income” method, which places a heavy emphasis on intangible assets. It’s also possible to calculate the value of a private company by making a comparison with an equivalent public company and making appropriate adjustments. Business value can also be estimated by anticipating cash flow over a three- to five-year period, and adjusting that into current dollar amounts.
Business valuation tends to rely on sophisticated financial calculations, good judgment on likely prospects for a business, and an astute assessment of a variety of intangible factors. For that reason, business valuations should never rely on an owner’s best guess. A professional accountant will be able to advise you on which valuation methods will be best suited to your individual business circumstances.