Businesses exist to create revenue, but revenue isn’t the only way to ascertain a company’s worth. As a business owner, you will likely need to determine your business’s value at least once, but how is that accomplished? Business valuation approaches vary depending on the type of business and the reason for the valuation. Understanding the fundamentals can help you engage the right professionals and maximize the valuation of your business.
The Fundamentals of Basic Business Valuation Approaches
Business valuations are not absolute. The measure of a business’s value may vary depending on the reason for the valuation and the nature of the business. Appraisers experienced in business valuations—especially valuations in your particular industry—are instrumental in helping to accurately determine your company’s value in a way that best suits your purposes.
Below are several business valuation approaches that are commonly used to determine a business’s worth. Using each approach at the same time for a single business would likely yield different results, so you should be sure to hire professionals who are qualified to appraise a business like yours for the purpose at hand.
When Valuing Your Business is Necessary
Valuing your business may be necessary for any of a variety of reasons:
- Selling the business;
- Entering a joint venture;
- Seeking capital through a loan or the sale of an interest;
- Applying for a loan;
- Adding a partner;
- Making a business succession plan;
- Developing a business exit strategy; or
- Dealing with a divorce.
Experienced professionals know how to choose from the various business valuation approaches to best reflect the value for your business to suit the purpose of the valuation.
Common Business Valuation Approaches
Knowing how to value your business means knowing which business valuation approach to employ in that endeavor. The valuation approaches discussed in this article fall into one of three categories:
- Market-based valuations;
- Asset-based valuations; or
- Income-based valuations.
Each approach focuses on a different aspect of the business and, as a result, may be better suited for one purpose over another. The choice of method is usually determined based on factors like the reason for the valuation, the size of the business, and the industry involved.
Market-Based Business Valuations
A market-based business valuation determines your company’s value by comparing it to the value of similar companies. The appraiser chooses comparables (“comps”) from companies that have recently sold. This method is fairly straightforward for large, publicly traded companies because records of the sales, including valuations, are likely to be a matter of public record. Moreover, ongoing share prices of publicly traded companies are readily available from the New York Stock Exchange (NYSE) or the Nasdaq.
This approach does not always work for privately held companies. Financial records and documentation of sales of these businesses are unlikely to be made public. As a result, a market-based approach may be difficult to use, and appraisers often choose a different valuation method.
Asset-Based Business Valuations
As the name implies, these valuations base a business’s worth on the value of its assets. This can mean totaling the replacement cost of the business’s tangible and intangible assets (liquidation value). This calculation is fairly easy to make, but it may not provide the best picture of the company’s worth. This method uses the book value of company assets, which could mean the depreciated value.
For a business that is not contemplating closing, the appraiser may choose to value it as a going concern. A going concern valuation generally assigns a value equal to assets less liabilities. However, this approach does not take into account intangibles, such as goodwill, which could add greatly to the business’s value.
The income-based valuation assigns a value to the business based on present or future income or cash flow. These calculations often use a capitalization rate (a rate of return). However, there is no fixed standard for cap rates; they are chosen by the individual appraiser based on the risks the appraiser determines the company faces. As a result, the value determined using this type of income-based valuation may vary from one appraiser to the next for the same business.
Why Your Business Valuation Method Matters
Valuing your business requires a specialized skillset. The choice of business valuation method to be employed can greatly impact the final value assigned to your business. Choosing the wrong valuation method or an appraiser who is not up to the task can greatly affect the sale price of your business, the terms of your loan, or another concern behind the need for the valuation.
Preparation is key to success in business, and the same goes for business valuations. Whether your business is headquartered in West Virginia (WV) and or elsewhere in the country, a WV business attorney can help you be prepared for a valuation whenever it is needed. Clients with business counsel benefit from legal advice on compliance matters, business opportunities, and more; informed recommendations about the right appraiser for your needs; and guidance through the appraisal process and other business matters.
Xavier W. Staggs at Jenkins Fenstermaker, PLLC is a WV WV business and commercial lawyer and entrepreneur who understands the legal and practical realities of running a business, including how to determine and obtain the right kind of appraisal for each client and situation. To learn how Xavier can help you choose among the business valuation approaches and obtain the right type of appraisal for your circumstances, schedule a consultation by calling (304) 523-2100 or complete this online contact form.