According to the U.S. Chamber of Commerce, business valuation is defined as “the process of determining the economic value of a business.” The valuation process gives owners, potential buyers, or other interested parties a reliable way to understand what a business is worth at a specific point in time.
A complete business valuation looks at all aspects of the business – things like the overall balance sheet picture, key personnel, market value of physical assets and intellectual property, and a forecast of potential revenue.
Top reasons to do a business valuation
Business valuations are important for transferring or expanding ownership inside the organization, for special tax considerations associated with gifting/estate planning and for S corporation elections, or when the company needs to raise capital for operations, expansion, or equity distributions.
In all these instances, interested parties must make important financial decisions that may have long-term implications. A properly structured business valuation helps the parties make these judgments with more confidence through a shared and objective view of a company’s worth. Business valuation is also critical in matters that involve litigation or specific tax liabilities:
- Formation of employee stock ownership plans (ESOP)
- Management equity plans
- Exit planning or buy-sell agreements
- Bankruptcy proceedings, shareholder disputes, or divorce litigation
- Determination of economic damages in fraud or intellectual property litigation
How the business valuation process works
There are several accepted ways to establish the fair value of a business. The one that fits your situation best will depend in part on your individual business model, the norms that apply to the industry in which you operate, and the practices of your evaluation partner. In most cases, your assessment will be performed in accordance with a professional business valuation standard. The process usually begins with a review of your company’s financial statements and comparisons to accepted industry metrics or benchmarks.
3 standard approaches that are accepted by the AICPA’s (American Institute of Certified Public Accountants) business valuation standards include:
1 – Income Approach
2 – Asset Approach
3 – Market Approach
Key considerations for business valuation
Apart from the direct transactional benefits of business valuations, they can also give owners valuable insights into their operations, including parts of the business that may be underperforming. Shoring up these areas can help prevent lost value in a future sale.
- Be clear on the purpose of the valuation. Are you preparing for a specific kind of transaction, or will this valuation serve as an overall baseline on the health of the company? You will get a more useful result if you and your evaluator are aligned on your objectives.
- Establish the right valuation frequency. The right business valuation cadence depends on the volatility of your market sector, your company’s sensitivity to regional or national legislative or regulatory activity, and market fluctuations for labor and materials. Generally, if you have never done a formal valuation, the sooner you start, the better.
- Pay attention to factors that may not appear on your balance sheet. The quality of your customer relationships, industry maturity curves, or high reliance on key personnel could also have an impact on the value of your business. Make sure that you and your evaluator are taking a 360-degree view of important influences that may reveal hidden value in your company.
How to get the right business valuation help
We advise business owners in the manufacturing, automotive, architecture and engineering, and industrial automation industries. We can help you get the right guidance on business valuation from accredited appraisers. Contact us to further discuss your individual business situation.