Business Valuation Basics

If you are a homeowner, you may know how much your home is worth. If you have a retirement account, you likely check the balance regularly. However, many small business owners do not know the value of their companies. This post covers business valuation basics.

In certain circumstances, obtaining a business valuation is very important, such as when preparing for a sale, planning for a future exit from the business, or obtaining investors.

A thorough, professional appraisal is essential to ensure the valuation’s accuracy. An appraiser’s method can be tailored to address your specific business and why you are seeking a valuation.

The Value of Valuing Your Business

Many business owners view third-party valuations as overly complicated, expensive, intrusive, and time-consuming. They may avoid learning the basics of business valuation. However, knowing your business’s value is necessary when preparing for a sale. In addition, there are several other common reasons for obtaining an independent business valuation:

• Exit planning
• Obtaining financing from a lender
• Raising capital from investors
• Insuring the business
• Implementing an owner buyout agreement
• Tax, estate, and succession planning
• Getting divorced and dividing assets
• Uncovering areas for growth and expansion

For some businesses, obtaining detailed business valuations at regular intervals can avoid the expenditure of resources in the wrong places and help identify investments with higher growth potential.

Business Valuation Methods

There are several ways to calculate business value. The three most common approaches to business valuation are asset, income, and market-based approaches.

• Asset-based business valuation. Determining a business’s value using the assets it owns focuses on its book value, which is derived from the balance sheet. Using this approach, business assets—tangible and intangible—are valued and totaled, while liabilities are deducted. Determining the value of intangible assets can be tricky, so obtaining a professional appraisal is essential.
• Income-based business valuation. Another standard method for valuing a business is to use its cash flow figures to project future income generation. Newer businesses and established businesses may use slightly different income-based approaches.
• Market-based business valuation. A market approach to business valuation looks at the purchases and sales of similar local companies. However, one downside of this method is that it could result in a business being undervalued relative to its assets and earnings.

A professional appraiser may determine that combining these three methods will provide a fairer and more accurate business valuation.

Involve a Business Lawyer in Important Transactions

Many online business valuation calculators provide instant estimates of how much a company is worth. However, these simplified formulations are not a substitute for a professional, credentialed appraiser who can apply the most appropriate methodologies for your industry and circumstances.

Along with a credentialed business appraiser, a lawyer should be part of your team when preparing for important transactions such as a business sale. Learn the value of an experienced business attorney: Book a Free Discovery Call today.