What Is Business Valuation? | Aprio
August 22, 2022
At a glance:
- The main takeaway: It can be challenging for small business owners to objectively assess the value of their business.
- The impact on your business: Business valuation is the process of determining the economic value of a business or company. It provides decision-makers with an estimate of how much the business is worth.
- Next steps: Planning for exits, taxes, mergers and acquisitions and employee stock incentive plans are all excellent reasons to get a professional business valuation.
The full story:
If you’re one of the 30 million small business owners operating in the United States, you’ve invested time and resources, and have probably made some personal sacrifices along the way to build a successful business. With these sacrifices in mind, getting the best value for your business is likely a top priority. This means putting a price on the passion, effort and time you have put into creating a thriving venture.
But it can be challenging to objectively assess a venture’s worth after investing in it for years. This is where business valuation comes into play.
What does business valuation mean?
Business valuation is the process of determining the economic value of a business or company. The fundamental purpose of the valuation is to provide decision-makers with an estimate of how much the business is worth.
A business appraiser considers various factors during a valuation. These include the company’s financial statements, history and outlook, business strategy and risks, industry and market trends, and the value drivers of the business.
These factors help valuation professionals make assumptions about future earnings, growth rate, and time horizon.
4 reasons to get a business valuation
You might need to determine the market value of your business for different reasons. The most common ones include planning for taxes, exits, mergers and acquisitions and employee stock incentive plans.
Whether you’re getting ready to retire, want to focus energy on a new project, or are just planning for the worst case scenario, strategizing an exit is one of the smartest moves business owners can make.
If you’re planning to sell your business, you’ll need to determine a base value. You’ll also need a strategy for increasing its profitability and value during the sale process.
A business valuation can help with both of these elements because it provides an estimate of the company’s worth and helps assess which factors affect its value.
This information will help you decide the right time to sell, what kind of buyer you should target and how much you should expect to receive for your business.
A credible business valuation will prevent inaccuracies that might make you sell your business at an unfair market value.
Tax planning and preparation
The value of a business affects the amount of taxes it must pay. The Internal Revenue Service (IRS) dictates that businesses are valued on their fair market value.
Valuations help determine gift tax liability and estate tax exposure. Gift tax liability arises when you give away an ownership interest in your business. On the other hand, estate tax exposure occurs when you die or pass your business on to your heirs.
Mergers and acquisition planning
If you’re planning to merge with or acquire another company, you need to know how much the target business is worth. This knowledge provides a starting point for negotiation.
A business valuation will also help you assess whether the other company is a good fit for your business. The valuation process will give you insight into the other company’s financials, operations and assets.
Employee stock incentive plans
If you have an employee stock incentive plan, your business should be valued yearly. A valuation should also be conducted prior to the initial offering.
Your business value affects how the stock compensation should be awarded to employees and how the stock compensation expense will impact the company’s financial results.
Regular business valuations help determine the stock price and facilitate the execution of the employee incentive plan.
3 approaches to business valuation
Business valuation specialists use different methods to calculate value. The ideal approach is often based on the purpose of the valuation and condition of the business.
The asset-based approach
This valuation method examines a business’s tangible and intangible assets. The appraiser adds up the value of its assets and subtracts any debts or liabilities as per the balance sheet.
The asset-based approach can be a going concern or a liquidation valuation. A going concern valuation assumes that your business will continue to operate into the future.
A liquidation valuation assumes you will sell your business and its assets. In this case, the net value will be the amount you would receive after paying off all the debts and liabilities.
The market approach
This valuation method compares your business to similar businesses that have been sold recently. The appraiser will look at comparable companies’ sales prices, revenue, and earnings.
For example, if you have a dental practice, the appraiser will need data about other dental clinics that have been sold over the past few weeks.
In the case of small business valuation, gathering such data is complicated by the fact that competitor data is not public. The lack of data makes the market approach imprecise.
The discounted cash flow method
The appraiser uses this valuation method when a small business is established and has predictable cash flows. Future cash flows are projected and discounted back to the present day.
This valuation method works on the principle that money today is worth more than money in the future. This is because you can invest the money and earn a return on it.
A discount rate is used to account for the time value of money and the riskiness of a business. The discount rate in this method represents the potential risk of your business not meeting its projections. The higher the discount rate, the lower the present value of cash flows.
What factors affect business value?
Your business value will depend on several factors. These include, but are not limited to:
- Business location, size and operating history
- Business growth rate and profitability
- The amount of debt your business has
- The availability of comparable sales data
- The condition of the industry and economy
These factors will affect the business valuation methods that specialists use and the accuracy of the valuation. The variances in the factors also mean two similar businesses can have different values. For example, a company located in a small town will have a different value than a business located in a large city.
Who is the best person to conduct a business valuation?
When it comes to valuation, the experience of your appraiser is everything. It’s essential to work with a team that understands your industry. Aprio has the industry experience and technical expertise to deliver the high-quality valuations required in today’s competitive marketplace.
As a recognized leader in the accounting profession and top workplace, Aprio is able to recruit and retain top talent and our valuation professionals carry accreditations respected by the profession.
Working with a full-service firm also provides fast access to additional services to enhance valuation outcomes, drive growth, manage risk and protect wealth.
That makes Aprio, the business advisory and CPA firm, the premier choice for your small business valuation.
How much does a business valuation cost?
The cost of a valuation is relatively small compared to the value it delivers to the company and its owners. A quality business valuation report details the appraiser’s methodology, assumptions and conclusions. Periodic business valuation should be considered a cost of doing business.
How often should you calculate your business value?
It’s a good idea to calculate your small business value at least once a year. Frequent calculations will give you an accurate picture of your business’s worth. It will also help you make informed decisions about your business, such as when to sell or how much equity to give up in a funding round.
You should also recalculate your business value if there are significant changes in your business. Examples include a change in ownership structure, a substantial increase in revenue, or a large decrease in expenses.
What is business valuation? Find out and start investing in it.
Now that you have a good understanding of how to value a business and the different small business valuation methods, you are ready to make an informed decision about the process.
Aprio’s business valuation specialists care about your business and want you to succeed. They have the expertise and technology to perform an accurate, fast, and high-quality valuation that weathers the scrutiny of regulatory authorities and auditors.
Explore our business valuation services and what you’ll gain from working with us.