When businesses are being valued, it is usually the entire enterprise value that is sought. You will generally see such valuations if the company is offered for sale, a transfer of ownership is contemplated, or for investment purposes, whether debt or equity.
You may wonder: are all business appraisals done on the total business enterprise basis? Not necessarily. Consider a situation when business owners want to divest of part of the business. Perhaps a single division is to be spun off from the parent company. Here, the owners will likely be interested in the value of just that segment and not the entire business.
Valuing a part of the company presents a set of challenges. A key question you are likely to face is whether the business is organized into well defined business units. If so, business income and expenses can be attributed to each business unit as if it were a separate company.
Even then there are some differences between a truly independent firm and a business segment managed as a separate profit and loss center. Chances are the business units have access to central company resources on special terms. For example, the parent company may be helping with supplier negotiations or offer a central research and development function for the business units to use. Or perhaps the business unit takes advantage of the central corporate marketing organization in order to gain access to certain market segments.
To make your business segment valuation realistic, you will need to identify all such special arrangements and economic advantages they offer. If the business unit is to be valued on a standalone company basis, you would need to adjust the income and expenses accordingly.
This is similar to situations when an independent company enjoys some special arrangements that you do not expect to continue past the valuation. For example, the firm may be leasing its premises from its current owners on terms that will not continue once the company sells. In this case, you would need to adjust the rental expense to market which will affect the available cash flow and, in turn, business value.
In summary, a business unit can be valued successfully as long as you can realistically attribute its income and expenses. In addition, you would need to make a judgment call as to the business risk once the business unit starts operating as an independent entity.
At one point or another most successful business people face the dilemma: do I figure out the business value by myself or outsource the project to an outside appraiser? The decision may depend on the reason why you need the business appraised.
Consider a strategic investment opportunity where all or part of an existing business if up for sale. The investor is ultimately responsible for making the decision on whether to invest, how much to invest, and for what share of business ownership. You may need to go through a number of what-if scenarios that involve different investment strategies before choosing the right one. Valuation itself will most likely be an iterative process where you consider a number of scenarios under different assumptions.
Going to an outside business appraiser is probably not a good choice here. The appraiser usually sells time and performs valuation under one set of assumptions. Considering different ways of approaching business acquisition is likely to be prohibitively costly and time consuming. At the end of the day, the decision to invest and how to structure your investment rests upon your shoulders.
In other words, business investment is an area of strategic decision making for a business person. Knowing the value of business investment is critical to making the right decision. That is one reason professional business investors such as venture capitalists usually perform their own business valuations.
Now consider a case of legal dispute, such as a divorce. Here, the accuracy of business valuation is less important than a legally binding agreement between the parties. To resolve the dispute, the judge is likely to appoint an independent business appraiser. The number for business value may not be highly accurate, but it is still enforced by the court. All the parties can do is abide by the judgment.
Here, the use of a business appraisal service is a necessity. The court is unlikely to accept business valuations from either party as biased. The independent business appraisal is called for as a compromise.
Other situations may not be as obvious. As a general guideline, a scenario where you largely control the outcome is best addressed with you having full knowledge and understanding of business value. In addition to business investments, partner buy-sell agreements and owner insurance coverage are good examples.
If, on the other hand, the situation involves parties with very different views, an independent business appraisal may be needed. In addition to legal battles, tax disputes and rigorous lender negotiations are typical examples.