Have you ever considered how much your company is worth? If you are like most business owners, the answer is yes, and almost daily. Knowing your business valuation is a critical component in the creation of a solid exit plan for your business. An accurate estimate on your business’s value provided by independent experts is vital to your future, your heirs, and any charitable plans you may have.
At some point or another, you will need to determine the value of your company, in which case, you’ll want to get an informal business valuation, which is an evaluation process conducted by a team of experts that takes into account many factors related to your business and your industry to determine how much your business is worth.
Reasons to Get a Business Valuation
There are many reasons why you’d want to know exactly what your business is worth. If you are planning to sell your business soon, going through a divorce, putting in place a succession plan for key management or junior partners 10 years from now, or just want to update your estate plan, you will need a business valuation. And, if your business will be the primary source of your retirement income, you should know how much you are going to get from a sale, net of taxes.
For estate planning purposes, a valuation can help you to minimize transfer taxes or future estate tax obligations, so you can plan accordingly. When it’s time for wealth transfer after you die, you want to be confident in the value that your heirs are to receive—and you want to ensure that the sale proceeds will be enough to support your spouse or beneficiaries and enough to maintain a healthy standard of living. You might also need to know the value of your business for purposes such as divorce settlement, recapitalization, business exit planning, or a shareholder dispute.
Perhaps most important, a business valuation can help you protect your most important asset and life’s work—the value of your business. This exercise will help you put in place or update a buy-sell agreement with your partners, or a business continuation plan in the event that one day you are not able to come to work and need to ensure the company continues to operate without you.
Formal vs. Informal Business Valuation
A formal valuation is a standard evaluation process that occurs when an independent expert spends a large amount of time examining a business’s records. This type of evaluation will use several different methods to determine the value of a company. Formal valuations carefully consider the three fundamental approaches to valuation: comparative transactions, capitalization of earnings, and asset valuation. They are more focused on the price of shares for the company than the company’s financial standing in the open market.
Formal valuations, which are typically completed by CPAs, investment bankers, or valuation specialists, are best when it is foreseeable that a party will present a challenge—they allow business owners to defend or explain their findings. For example, a formal valuation might be best when a business owner is going through a divorce.
An informal business valuation, on the other hand, can come in various shapes and sizes, and just about any professional can offer an informal valuation, such as lawyers, bankers, business brokers, or CPAs. It is based on wide-ranging criteria, but typically focuses on projections of discounted cash flow, comparative analyses, and multiples of net operating income applied to a particular industry. These valuations are also more concerned with the marketability of the business and the market value than the price of company shares.
Generally speaking, informal business valuations are less expensive than their formal counterparts because they are less in depth and involve less work. Many professionals will offer their clients informal, market-based valuations for free as a way to open the door with a business owner and to demonstrate value. Informal valuations do not include data review or the specific calculations behind the conclusions.
If you believe that your valuation is going to be scrutinized by a party, such as an ex-wife, an employee, a business partner, or a government entity, then it’d be best for you to go with a formal valuation. However, if you only need an accurate range of value of your business, then an informal valuation is all that you really need to get a better understanding of your business’s financial worth in the market.