Business valuation is a specialized discipline that consolidates a variety of general, financial, and economic business concepts. To reach a reasonable measure of value for a closely held corporation, the business appraiser must possess a comprehensive knowledge of public exchange dynamics, and engage in a meticulous, systematic process consistent with commonly accepted valuation practice and theory.
Although it is the valuation expert’s choice to conduct the required analysis, a broad understanding of how to determine value can be of significant advantage to a small business owner, whose principal purpose is to generate value for investors and shareholders. The owner will almost surely be included in some capacity when it comes to assessing the firm’s value, whether to complete a mergers and acquisitions transaction, evaluate a new growth opportunity, or for any other determination. Experience with the basics of business valuation can help ensure an essential addition to the effort.
Business Valuation Questions
A closely held business’ value will evolve based on myriad factors such as the overall industry condition, growth potential, stability of the customer base, strength of the management team, cash flow, profitability, and sales volume. However, there are various reasons other than selling why you may need to conduct a business valuation. A few include dealing with taxation matters or stockholder disputes, creating an ESOP, drafting a buy or sell agreement, or a divorce. A valuator needs to see a business’s financial information and identify many other details about a company to properly appraise it. Below is a list of some questions that a business valuator will likely ask as part of the valuation process regarding various areas of your small business. Not all of the issues concern every type of company and this is certainly not an exhaustive list.
- Business Organization: Is the business legally organized as a partnership, sole proprietorship, corporation, or other? If other, how is it organized?
- Business History: Is the company engaged in any joint ventures or similar projects?
- Products and Services: What are the company’s primary services or products?
- Marketing: Who are the current principal clients?
- Finances: What warranties exist in connections with liabilities?
- Facilities: Is real estate leased or owned? If leased, what are the lease terms? If owned, what is the appraised value?
- Personnel and Organization: How many workers does the corporation employ?
- Management: What is the background of each of the key management members?
The valuation process for your small business will provide you with a better understanding of the principal factors that further enhance your business’s value. With this knowledge, you can focus your resources, energy, and time in these areas rather than in those that provide little or no value to your corporation.
There are three fundamental approaches to estimating the value of a privately held business, and multiple strategies exist within each approach. The first is the income approach, in which net cash flows, or future economic benefits, are calculated and transformed into value by employing a rate of return reflecting the risk associated with the predictions. In other words, the income approach estimates the existing value of all expected future net cash flows, taking into account the possibility that those cash flows may not develop as expected.
Under the market approach, compounds of several financial performance metrics scrutinized for comparable publicly traded entities, such as enterprise value and EBITDA, enterprise value and revenue, and performance price and earnings, are applied to a private corporation to arrive at an estimate of value.
Finally, employing the asset approach enables measuring value by subtracting the current market value of liabilities from the current market value of assets. This approach implies that the business’s value is equivalent to the theoretical net cost of assembling from scratch the organization’s particular collection of assets and liabilities as of the valuation date.
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