How to value a business
Sooner or later, this questions pops up for most business people. Whether you are selling or buying a business, hand the reins to a younger generation, seek investment to grow the company, or need to fend off legal challenges, the issue of business value comes up.
Most business people have no clue about business valuation
Now if you are like the typical business person, you are busy running the company. Measuring what it is worth is not the sort of thing you do regularly. The same holds true for most business professional advisors, including CPAs and lawyers. Business valuation is a specialized area that calls for know-how and attention to detail.
Just like with any business chore, cutting corners does not pay dividends. You can ask your business partners for advice, but odds are they know little. Opinions and anecdotal suggestions are no help, most are misleading and overly simplistic. The devil, as the saying goes, is in the details.
How to value a business – a high stakes game
Trouble is, business valuation is about as important a decision making point as it gets. Just consider the amounts of money at stake. Mishandling business valuation is likely to cost you thousands, result in a failed business transaction or a court judgment you will hate. Ask a seasoned business broker and your will hear an uncomfortable statistic: nine out of ten private business sales fall through because the buyer and the seller do not agree on the business value and its selling price.
Courts and tax man use business appraisals aggressively
It gets even more troublesome if you face a legal challenge or questions from the tax man. Courts have a way of enforcing their point of view and you may find a court appointed business appraiser does not agree with your idea of business value. Unfortunately, such business valuations are binding on all parties and professional business appraisers are trusted by courts and tax authorities.
Approach business valuation with respect
Whenever professionals are needed for a business task, you can surmise it is not easy. Indeed, business valuation has a lot of moving parts. For one thing, there are three fundamental ways to value a business. No one way, or approach to valuing a business, is definitive. Put another way, there are several ways to look at what a business is worth. Each approach offers a different perspective. Business appraisers are a detail oriented lot, leaving no stone unturned in their quest for measuring business value.
How to value a business? Three ways to do it
The three ways are formally known as the asset, income, and market approaches. Investing in a business requires capital to acquire business assets. The cost of creating a successful company is considerable. The asset approach seeks to reveal business value based on its operating assets and liabilities.
On the other hand, you can view any business as an income producing entity. Making money at an acceptable level of risk is the key objective and this is the view taken by the income approach to business valuation.
In the real world, businesses operate in a competitive environment. Similar companies can be compared to see what they are worth. Such comparisons are the cornerstone of the market approach.
If you take a look at a professional business valuation, all three approaches are used to figure out what a business is worth. In conclusion, business appraisers like to tie all their findings together in stating the business value. It could be an average of all the calculated values, or a range.
Troubled by business value result? Check the assumptions
One reason business valuations cost good money is that business appraisers are expected to study reams of business information in order to make careful assumptions and express their educated opinion at the end of the report provided to the clients. Such assumptions drive the conclusions of business value. If you have trouble buying the number, go back and review the assumptions.