A business valuation is an important process for any business owner, regardless of the size or type of their business. It’s particularly important if a business is planning a transition or change in structure, or an estate or succession plan is required.
A professional valuation can help a business owner determine if they’re making the most of their investments. By understanding what goes into a business valuation, as well as who should perform it and when it should be conducted, owners can make informed decisions about their business.
This article will provide an overview of business valuations and answer the following questions.
- What is a business valuation?
- What are the main business valuation methods?
- What is a 409A valuation?
- When and why should you conduct a business valuation?
- What are the steps of a business valuation?
What Is a Business Valuation?
A business valuation is the process of estimating the value of a company and provides an estimate of the company’s worth for situations such as preparing for financial investments, or selling or buying a business.
Valuation reports can help you assess your strengths and weaknesses so you can make informed decisions about how best to increase profitability in the future.
Valuation reports can also be instrumental when seeking financing or investments from lenders or investors.
What Factors Are Used in a Business Valuation?
Business valuations involve a complex process of assessing the worth of a company. Multiple factors are considered, such as:
- Size and condition
- Industry
- Location
- Economic climate
- Financial performance
- Intangible assets including intellectual property and brand recognition
Market conditions can also drastically alter an assessment of a business’s worth. It’s necessary to take all these into account to arrive at an accurate valuation that represents interests of both current owners and potential buyers.
What Are the Main Business Valuation Methods?
Several techniques are used to carry out this process. The three primary approaches for estimating value include:
- Market approach
- Income approach
- Asset approach
Market Approach
This approach compares the business to similar guideline companies using valuation ratios based on those companies’ current market prices and historical or projected financial data. Those valuation ratios are then applied to the business’ adjusted historical or projected financial results.
This method is useful for businesses at various stages of their lifecycle.
Income Approach
Income-based valuations use projected cash flow or profitability of the business, cost structure, and more to determine value.
This technique works best for businesses that have a reliable profit stream from operations. Analysts consider current and potential revenue, expenses, capital expenditures, and changes in other assets and liabilities to determine a company’s future cash flow.
The expected future cash flows are discounted to present value at an appropriate rate of return for the investment. The selected discount rate or rate of return should reflect the degree of uncertainty or risk associated with future returns.
Asset Approach
This approach considers the current costs of reproducing or replacing an asset, subtracting accrued depreciation from physical deterioration, functional obsolescence, and economic obsolescence.
Understanding what tangible and intangible assets can add to your business’s worth is essential.
Reconciliation
The method typically depends on the type of company being valued or the industry it operates in. Involving knowledgeable specialists in the valuation process is essential as they understand which factors to consider.
What Is a 409A Valuation?
The term 409A valuation describes a business valuation used to determine the fair market value of the various classes of equity of private companies. It’s typically required when companies offer stock options or other forms of equity compensation to employees. Its purpose is to set an objective fair market value for a company’s common stock.
The primary difference between a 409A valuation and a business valuation is that a 409A valuation focuses heavily on the company’s common stock not the total value of assets and liabilities. The value of the company’s common stock may also be impacted by factors such as lack of control or lack of marketability.
When and Why Should You Conduct a Business Valuation?
A business valuation is an important process for any business owner, regardless of whether they plan on selling their business in the near future.
Knowing the value of a company can be especially helpful with:
- Structure change
- Business transition
- Estate and succession planning
- Decision-making
- Allocating resources
Structure Change
Valuations should be conducted when there are any changes to the structure of the business, such as:
- Raising capital
- Shifting services
- Significant market changes
This will help provide insight into how these changes may affect overall value and help owners make informed decisions about further investments or strategies.
Business Transition
When looking to transition your business, it’s essential to have a professional evaluation done so all parties involved understand the value of the company and can make informed decisions. Regular valuations can help track progress and performance in comparison to industry peers.
Estate and Succession Planning
A valuation is important for estate planning prior to succession planning. Having an accurate assessment of a company’s worth can help determine fair shares for heirs and avoid potential disputes.
Having a current valuation when transitioning ownership of a company can help with distributing assets to all involved parties.
Allocating Resources
Assessing performance compared with other companies within the same industry can help with decisions about where to focus resources and efforts to remain competitive.
What Are the Steps of a Business Valuation?
Understanding the steps involved in a typical business valuation will help owners get the most out of their appraisal.
It’s important to hire an experienced professional and experienced valuation expert. with an understanding of finance, accounting, and tax law, and an objective outlook.
Hire a professional who specializes in business valuations or has credentials such as Accredited Senior Appraiser (ASA) or Certified Valuation Analyst (CVA) knowledgeable about the industry and current market conditions, as well as the type of business being valued.
A typical business valuation usually consists of three stages:
- Data collection
- Analysis
- Reporting
Stage 1: Data Collection
Data collection involves gathering financial documents such as income statements, balance sheets, tax returns, and other relevant documents. This helps the valuation expert assess the current performance of the business and how it compares to other similar companies in its industry.
For a comprehensive assessment of a business’s worth, it’s essential to have:
- Financial documents such as the balance sheet, income statement, and cash flow statements provide insight into the company’s financial health
- Details on management team expertise, industry developments, and market size must be considered
- The history and operations of the organization, including products or services they offer, customer relationships, and any liabilities that may affect value
- A record of intangible assets such as brand recognition or intellectual property should also be considered to obtain a precise valuation
Stage 2: Analysis
At this stage, professional valuation experts use financial models and other techniques to calculate an estimated enterprise value for the business based on the data collected in the previous step. Once the enterprise value is established, the equity value can be determined by subtracting debt and other long-term liabilities. The equity value also becomes the key component to the determination of the common equity for a 409A valuation.
Stage 3: Reporting
Findings are presented to management and owners or shareholders. The valuation expert will provide an opinion based on analysis on what they believe to be a fair price for the company and any common stock.
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For more details on business valuations for your company, contact your Moss Adams professional.