Do You Need a Business Valuation?
Whether you’re buying or selling a business, a business valuation is a necessary step in the process. You might be more familiar with the term ‘business appraisal’. These two interchangeable terms describe a complicated process used to determine what a business is worth.
While you’ve likely heard of a business appraisal, you may not be aware that there are different types of business valuations for different circumstances. There are some circumstances where a formal valuation is needed. In other instances, a less formal approach can be taken.
When you work with a Sunbelt Texas business broker, we will help you navigate the various types of business valuations and determine which type of appraisal you need for your specific circumstances.
In the last 20 years as business brokers in Houston here’s the question we’ve been asked by small business owners approximately 10,000 times:
“What Is My Small Business Worth?”
Every business owner wants a simple clean answer. And unfortunately, too many business brokers, CPAs, and fishing buddies are more than happy to give them a simple yet incorrect one. But intuitively we know this can be a complex question to answer. The process of pricing a small business is like preparing a complex meal. You put in a lot of key ingredients to get to the end result.
9 Key Ingredients for Pricing a Small Business Correctly
- Sales revenue – is the business growing? Shrinking? Is it volatile year-to-year?
- Profits – after adjusting for the owners often way too complex or obscured earnings, what profit is the business actually making?
- Customer Concentration – Is the largest customer a large part of the total business sales? Is it the same large customer every year? What is the risk of losing that customer?
- Vendor concentration – is the business dependent on a critical supplier? Is there a replacement supplier if something goes wrong?
- What family members are involved in the business?
- Any big industry or regulatory changes in the works? Good or bad?
- Financial records – Does the profit and loss statement accurately reflect the financial performance of the business? Can the tax returns and P&L be reconciled easily?
- Is the accounting done on a cash basis? Accrual? Are tax returns and financial statements prepared with consistent accounting principles?
- What is the current interest rate environment? Generally speaking the higher the interest rates the lower the business value to a buyer due to the higher cost of borrowing to pay for the business.
And there are about 12 – 15 more issues that need to be considered when determining what a buyer might be willing to pay for the business. My advice is to ignore “Rule of Thumb” business pricing methods. Instead, contact us to set up a confidential discussion with a Sunbelt Texas professional. We’ll guide you through the process of determining what is an appropriate price for your business in today’s market.
It’s important to know what type of business valuation your transaction requires. Here is a summary of the most common types of appraisals.
Types of Business Valuations/Appraisals
- Business Appraisal “Calculation of Value” – this valuation is often used in Buying a Business or Selling a Business. The premise is that buyer has no formal ties to the business and the transaction is an arm’s length transaction for the sale of 100% of the business. This valuation is generally viewed as a purely financial opinion of market value and makes no assumptions about how a specific buyer might value the business.
- Estate Plan Valuation – This is a valuation done for business owners who have the business inside their estate and required the appraisal for tax planning issues
- Buy/Sell Partner Appraisal – This is often used when one business partner is buying out another business partner.
- ESOP Appraisal – This is used when the company is installing an ESOP (Employee Stock Ownership Plan) so that the employee-owners have a way to understand the value of their business ownership interests.
- Divorce Valuation- Self-explanatory and similar in many ways to the Partner Buyout Valuation listed above.
- Personal Goodwill Valuation – Sometimes used in a business transaction where an owner is personally involved and critical to the business. For instance, a world renown heart transplant surgeon likely has a lot of personal goodwill built up because people seek out that surgeon INDIVIDUALLY. If that surgeon left the business it’s likely many patients would not contact the business.
- Minority Interest Valuation– This is a valuation used to assess the value of an interest in a business where the minority ownership is not liquid. For instance, if I own shares of IBM I call my broker and have the shares sold at a published price in 5 minutes. However, if I own 10% of XYZ, Inc. which is not a publicly traded company with 90% owned by my boss Mary, then I would need to try to find someone to buy my 10%. In this case, since Mary owns 90% of the company and is my boss, my 10% is probably not worth 1/10 of 100% value of the company. This valuation helps determine what your 10% is really worth.