Quite often, small business owners do not see the value in getting a business valuation completed. Perhaps there is no urgency to complete one, or the owners felt one was not needed, or the valuation seems cost-prohibiting.
Here are some reasons owners value their business:
Tax (estate/gift) planning purposes
Sell the business
Attract new investors
Buy out other owners
Apply for a loan or line of credit
Understand their business growth
Different approaches are considered in business valuations. One approach or a combination of approaches may be used in the business valuation calculation. Generally accepted approaches to valuation and some methods include:
Asset Approach – a value indication of a business based on the value of the assets net of liabilities. The Adjusted Net Assets method is used to value a business by calculating the fair market value of its net assets. This provides a floor value. It is commonly used for holding companies and companies with consistent losses.
Income Approach - the “earning capacity of the company” is calculated by converting the anticipated economic benefits into a single amount. The Capitalization of Earnings/Cash flow method is generally used for mature companies with consistent cash flows. The Discounted Cash Flows (DCF) method is preferred if historical net income is not a proxy of the future. This is used for start-up companies and companies with uneven growth.
Market Approach – this references recent sales of reasonably comparable companies (“comps”) for which transaction values are known. The Completed Transaction Method (CTM) uses private company sales data to establish price multiples that are applied to the subject company to compute a valuation amount. However, without a sufficient number of comparable sales transactions this method may be eliminated from consideration.
What are the different types of business valuations?
Detailed Valuation - a comprehensive and objective report that is written to stand up to the scrutiny of the courts, the IRS, and other reviewing agencies.
Summary Valuation – similar but shorter than the detailed valuation report. Generally not for review by courts or agencies.
Calculation Report – A report composed from the business owner’s direction. An example would be calculating the value of a target company based on various synergies the owner expects from the acquisition.
Getting a business valuation completed is not as intimidating or exhausting as it may seem. Please reach out to me if you have questions or are interested in understanding how this process works.