Oftentimes, business owners require a valuation of their company to protect their wealth or comply with various laws and regulations. Determining the fair market value of a business is achieved via a complicated process, which a professional appraiser can conduct.
The Purpose Behind A Business Valuation
There are numerous reasons for performing a business valuation. For example, you may want to buy or sell a business, set up a buy-sell agreement or create a succession plan. There are other reasons as well. You may want to develop an estate plan to help reduce taxes or assist your attorneys in litigation matters such as a divorce settlement or lost profit damages.
In addition, a valuation is practical for assessing life insurance coverage needs, as well as estate planning and filing estate or gift tax returns. Valuations can also help resolve disputes related to shareholder agreements, divorce litigation, or economic damage calculations.
You will also need a valuation to comply with Financial Accounting Standards Board requirements for a business merger or acquisition and on a post-M&A basis to test intangible assets for impairment.
Moreover, if you’re converting your C corporation to an S corporation, a valuation will help establish a basis for the company’s common shares of stock and its potential “built-in gain,” which may be subject to taxes if the business (or a portion of it) is sold within a prescribed holding period (which is five years for businesses that made S elections in 2013).
Methods Used When Valuing A Business
Financial statements provide a useful starting point for valuing a business, but they only reflect historic values and operating results. Business valuations deal with future earnings, since prospective buyers are not purchasing your company’s past performance. To get a complete picture of your company’s worth, valuators perform an intense analysis of your company’s strengths and weaknesses, organizational structure, competition, opportunities, and tangible and intangible assets. External factors such as economic and market conditions also impact value.
An accredited valuation professional is skilled in selecting relevant valuation methodology. Not all appraisal methods apply to every business valuation assignment.
Under the cost or asset-based approach, business value is the difference between the combined value of the fair market value of assets and that of liabilities. It is quite useful to businesses — asset holding companies, for example — that rely on hard assets and possess few intangible assets.
The income approach determines the present value of a business’ anticipated future cash flows, which are discounted at a rate of return on par with the company’s risk. It is a practical methodology when valuing businesses with considerable intangible assets such as goodwill.
Last is the market approach, which estimates pricing multiples from sales of similar private businesses or comparable public stocks. These multiples establish relationships between actual transaction prices and the comparables’ economic performance, for example, price-to-earnings or price-to-sales. To obtain a meaningful sample of comparables, valuators use various selection criteria, including standard industrial classification code, transaction date and size.
Within each of these three basic approaches there are various valuation methods that may be applied, depending on the availability of data, your company’s distinct characteristics, and the specific purpose of the valuation.
Valuations go beyond these methodologies. The analyst must also consider if the ownership interest is one that can control the entity’s activities. It is logical to assume that a willing buyer would pay less for a non-controlling interest and it’s the analyst’s challenge to determine that discount, if any.
Determining the differences, if any, in value of a pass-through entity such as an S corporation, to that of a C corporation, are critical to the conclusion of value.
Every business is unique and stands on its own merit. There are no formulas to plug data into when it comes to arriving at our opinion.
Experienced, trained, and certified business valuators bring integrity and objectivity to the valuation process to tackle these concepts.
Not As Easy As It Seems
As you can see, there’s more to valuing a business than meets the eye. Because it is such a complicated process, it is critical that you retain a qualified valuator to appraise the business.