Demystifying business valuations
Business valuations are one of the most misunderstood tools for a business owner. There are many reasons to conduct a business valuation. These include, but are not limited to, buying a business, selling a business, financial expansion, estate planning, retirement planning, owner income and wealth protection, property modification, and, Unfortunately, the divorce of the owner.
You should expect to pay more than $3,000 for your appraisal. Depending on your annual income and your situation, the fee could be closer to $10,000. It’s worth every penny as long as you find a reliable service.
Business valuations are much more complex than taking an industry multiple and doing a few simple calculations. Stay away from the wonderful $199 deals that may come your way. A good business valuation will provide the owner with the value of the tangible asset and the value of the intangible asset. Most companies will have a strong value of intangible assets. If you’ve worked for 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 difficult to find in the starting line for any loan application.
Quality business reviews will actually assess 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.
one. Asset-Based Approach
two. Income-Based Approach
3. market-based approach
active Based on or book value is an accounting formula that subtracts total liabilities from total assets. Typically, asset-rich companies with low cash flow score well with this approach.
Entry The based approach is all about earnings and cash flow. Sustained revenue streams are capitalized into an operating value. You need more than a financial calculator to get the correct answer with this approach.
market based approach is the most direct approach to determining fair market value. This approach uses prices from benchmark public companies (when and if available) and from private transaction markets (Mergers and Acquisitions). These companies are known as guide companies because no two companies are truly comparable.
Avoid using your accountant for a business valuation. A good accountant is better off maximizing your deductions through asset depreciation, company vehicles, health care, retirement funds, and other tax-friendly strategies. These deductions can and will be unraveled to restate the financial statements to optimize fair market value. Don’t worry, the IRS doesn’t have access to company valuations, and the courts have confirmed that they can’t be used for tax audits.
At the end of the day, you want to know how much a buyer will pay for your business in today’s market. Most accountants do not understand the effect that proper terms and deal structure have on the purchase price. They have limited resources to analyze what genuine supply and demand a specific business will generate in the market.
If you are getting an appraisal to determine a sale price, make sure the appraisal includes a justification for purchase test (JOPT) and a debt service analysis.
Don’t go over dollars to pick up pennies. He would be sick after closing a deal knowing the buyer would have paid $100,000 more, all because he didn’t have a quality business valuation and the buyer did. He passes all the time. You know that if your business is priced too high, it won’t sell.