Business owners spend considerable time and energy trying to promote their company value by developing growth plans with well-defined goals. These plans are targetted to maximize value over time, but it’ is difficult to achieve those goals without knowing where to begin.
Not only do business owners need to understand what their business is worth; they also need to know what supports and drives that value. Many times, the owner's over-confidence or apathy causes this step to be neglected, or at a minimum, based on incomplete data or conjecture. In this case, a valuation usually serves as a reality check for owners with a biased or uninformed viewpoint on what their business is worth.
Why would a business owner want a valuation?
The traditional answer is that valuations are needed to resolve tax or legal issues. However, valuations are actually performed for a myriad of reasons, including but certainly not limited to selling or acquiring a business. In the cases of death, disability, disaster or divorce, valuations are needed to equitably determine the business assets according to terms spelled out in legal filings.
Valuations are often needed when gifting or donating company stock as part of a charitable contribution, in resolving IRS or shareholder disputes, or when converting a C-corporation to an S-corporation. There could be requirements in a buy/sell, partnership or shareholder agreement that necessitates a business valuation.
In addition, owners would generally perform a valuation when attempting to raise strategic capital or obtaining a Small Business Association (SBA) loan. Implementing an Employee Stock Ownership Plan (ESOP) would certainly necessitate an initial and annual valuation.
Moreover, a formal business valuation can help to reconcile perceived opinions on value, and coupled with a marketability analysis, it can help a business owner determine relative value in the marketplace.
How does the business valuation process work?
The assessment of value is indeed an art form as much as it is a science. Business valuation is a process and a set of procedures used to estimate the economic value of an owner’s interest in a business. An accurate valuation of a closely held business is an essential tool for a business owner to assess both opportunities and opportunity costs as they plan for future growth and eventual transition.
It provides either a point-in-time assessment of relative value for an owner, or perhaps the price a buyer would be willing to acquire the business. On its face, business valuation is actually a relatively simple and straightforward concept. A qualified professional first analyzes the subject company’s financial statements and considers comparable transactions, industry ratios and other quantitative and qualitative information. Then, applicable adjustments are made to align the subject company to an industry standard or benchmark.
Despite the benefits, however, many business owners are apprehensive about what to expect when going through the valuation process. In some cases, valuations can expose areas of the business which actually take away from value, such as weak financial and accounting controls, under-performing assets, and weaker operating ratios relative to its peer group. The entire valuation process can provide an overview of the strengths and weaknesses of the reviewed company.
What are the key considerations for a business valuation?
The business valuation professional will first consider the purpose and objective of the valuation. They will then look at the nature and background of the business, its products, and services, as well as the industry life cycle, economic and political environment. Unique factors are then considered, including customer relationships, executive compensation, as well as excess assets, working capital, and liabilities.
Considerations that could have a profound influence on value include goodwill or other intangible assets, the dependency on an owner or key employee(s), diversity of the customer base, market position, and the competitive landscape of the industry.