Demystifying Business Valuations

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Business valuation
Business valuations are one of the least understood  tools for a business owner.   There are many reasons to perform a business valuation. These include but are not limited to buying a business, selling a business, financing expansion, estate planning, retirement planning, protecting owner income and equity, modifying ownership and unfortunately, owner divorce.

You should expect to pay over $3,000 for your valuation. Depending on your annual revenue and situation the fee could be closer to $10,000.   It is worth every penny provided you find a reputable service.  

Business valuations are much more complex than taking an industry multiple and doing some simple math. Steer clear of $199 wonder offers you may be presented.   A good business valuation will provide the owner with the tangible asset value and the intangible asset value.   Most businesses will have a strong intangible asset value. If you’ve worked years to build a loyal customer base, you deserve credit for that intangible asset.   This is very lucrative in the eyes of a buyer, but hard to find on the line item for any loan application.

Quality business valuations will actually evaluate your business through at least 3 lenses.   Each lens is designed to approximate or reveal the Fair Market Value (FMV) of the business. Below are three of the most common approaches  used in business valuations.
  1.   Asset Based Approach
  2.   Income Based Approach
  3.   Market Based Approach

Asset based or Book Value is an accounting formula that subtracts total liabilities from total assets. Typically, low cash flow asset-rich companies score well using this approach.

Income based approach is all about earnings and cash flow. Sustained income streams are capitalized into an operating value. You need more than a financial calculator to get the right answer with this approach.

Market based approach is the most direct approach for determining fair market value.   This approach utilizes pricing from guideline public companies (when and if available) and from private transactions (Merger and Acquisitions) markets. These companies are referred to as guideline companies because no two companies are truly comparable.

Avoid using your accountant for a business valuation. A good accountant is best maximizing your deductions through depreciation of assets, company vehicles, health care, retirement funding and other tax friendly strategies.   These deductions can and will be unraveled to recast the financial statements to optimize fair market value.   Don’t worry, the IRS does not have access to business valuations and courts have upheld they can not be used for tax audits.

At the end of the day you want to know the most a buyer will pay for your business under the current marketplace.   Most accountants do not understand the effect proper terms and deal structure have on purchase price. They have limited resources to analyze what the genuine supply and demand a specific business will generate in the marketplace.

If you are getting a valuation to determine a selling price, make sure the valuation includes a Justification of Purchase Test (JOPT) and debt service analysis.

Don’t step over dollars to pick up pennies. You would be sick after closing a deal knowing the buyer would have paid $100,000 more all because you did not have a quality business valuation and the buyer did. It happens all the time. You know if your business is priced too high — it doesn’t sell.