Business Valuation - What, How and Reasons

For most small business owners, the most valuable asset they own is their business. But, if the owner needs to find out what the business is worth, determining its value isn’t as simple as looking up a stock price. For that, a business valuation is needed. A business valuation is a formal process to estimate the value of a business. Business valuation is one part art and one part science. It relies on the professional judgment of an analyst who weighs the nature of the business, its financial performance, local and national economic conditions, values of assets and related liabilities, plus any unique know-how or proprietary technology to arrive at an estimate of the value of the business. Because every business is unique, there are no rule of thumb methods that will result in a reliable and defensible value. Valuation analysts use three main methods for their calculations. Which of the three – or possibly a combination of the methods – the analyst chooses in a specific situation depends on careful consideration of all relevant information. Overall economic conditions and changing demand for the products or services of a business may also play a role in the choice of method. The purpose of a valuation can also determine the most appropriate method. Asset-based approach: This method frequently results in the lowest value and is commonly used to set a floor for the value of a business. An analyst using this approach will determine the fair market value of the assets less any related liabilities. This approach may look at the collection of assets as components of a business that will continue as an ongoing concern, or it may assume a liquidation value, as if the assets were to be sold at a fire sale. Income-based approach: As the name implies, this method relies on the income the business generates. Typically, a weighted average of recent historical data is adjusted to result in a hypothetical stream of cash flows that a successor owner would receive. This stream of cash flows is then discounted to its present value. To derive future cash flows, historical income is normalized for unusual and non- recurring items, and to reflect the actual costs that a successor would incur to keep the business operating. Non-cash items such as depreciation are removed. Owners’ compensation is one of the most common normalizing adjustments. This is because owners typically control how much they receive, and this pay may or may not reflect actual market rates. In some circumstances, income projections into the future may be used if they are considered a more accurate reflection of future performance for the company. This is especially true for startups. Market approach: With this method, an analyst will look at recent sales of comparable businesses as reported in databases compiled by business brokers. The analyst may need to adjust the actual sales prices to reflect differences between the businesses sold and the business being valued. This method is most useful when there are enough comparable businesses that relationships between either revenue or net income and sales price can be determined. This method doesn’t work well if the business in question is unusual or if few similar sales of businesses can be found in the databases.

50 REASONS FOR A BUSINESS APPRAISAL

There are many reasons for valuing a business, and here are some of them: 1. To know what business is “worth” 2. To have an idea how the market would value the business should you want to sell 3. To set up a process that would make the company more marketable should the owner decide to sell or when they are ready to sell 4. To be used to consider an offer from someone who wants to buy the business 5. Creates a bigger playing field for owner to assess the results of their decisions or potential of wealth creation 6. The valuation is a method that can show how wealth is created and that can indicate a direction to go in 7. Can show how an initial operating cost can become an investment and how it can be recouped by increased value of the business 8. Places the owner in a position to measure the business in terms of value creation and not on the immediate profit (or loss) from a transaction 9. Identifies value drivers 10. Can possibly uncover areas of the business that can be exploited for greater current profit as well as long term growth 11. Can identify weaknesses or areas that reduce value 12. To establish a buy-sell agreement and a method of automatic adjustments 13. For updating buy-sell agreements 14. Shareholder or partner disputes 15. To freeze out minority owners 16. Business or owner life insurance purposes 17. To determine built-in gain for conversion of a C Corporation to an S Corporation 18. For owners’ personal financial planning 19. To use on owners’ personal financial statements 20. To be used as a guide to determine retirement or buy out payments to the owner 21. To indicate the value for credit purposes 22. To value assets and asset impairment for GAAP, i.e. financial statement, purposes 23. To be used as a guide to determine reasonable compensation 24. To plan for a merger with a supplier or competitor 25. To allocate costs in an acquisition or merger 26. To assist the dream of going public and capitalizing the business’ value 27. For gift tax purposes such as ownership transfers to a child, donations to a charity, transfers to grantor trusts or installment sales to a defective trust 28. For estate tax reporting purposes 29. For an estate’s division of assets where the business will go to one beneficiary and offsetting assets to another 30. To assist a beneficiary in selling an inherited share of a business 31. For succession planning 32. To set up, or value, an employee stock ownership plan (ESOP) 33. For stock compensation awarded to employees including restricted stock and stock option plans 34. To determine a base line and value growth for phantom stock arrangements 35. To value assets in a marital dissolution, divorce planning 36. To be used for prenuptial agreements 37. Valuation of business in a bankruptcy 38. To distinguish between enterprise and personal goodwill 39. To establish economic damages should there be a loss from a disaster and lost cash flow 40. To use as a benchmark to measure the business’ “growth” 41. Can provide measures of key numbers and ratios with peer companies 42. To be used in or to get started with strategic planning 43. To see if an independent appraiser can uncover hidden value 44. To determine if there is value greater than, or separate from, the present operations such as strategic value 45. To indicate how to recognize, maximize, build or grow and realize full value of strategic value 46. To raise owners’ mindsets from daily operations to that of creating long-term and sustained value 47. To understand the illusion of value and ways to make the value a reality. For instance, value can be lost very quickly when exposed to risks such as damage to reputation and regulatory overreach and valuations can assist in identifying the importance of this 48. Creates a broader vision for the business owners 49. Periodic valuations can be a tool to track the ways value is created assisting in strengthening the business 50. To help identify whether the business is a growing, stagnant or wasting asset Please call us at (248) 816-1220 or 800-276-8319 to set up a free consultation. Or Book Your Consultation here: We service clients worldwide.