A business owner may consider selling their company at some point. With both parties trying to secure the most favorable deal, business negotiations can quickly become complex.
Business valuations translate a company’s story, including its history, brand, products, and markets, into a currency-based value. Business valuations are often used by investors, owners, bankers, creditors, and even the IRS.
What is a Business Valuation?
During the sale of a business, the price is what you are willing to sell the business for and what someone will pay for it. Initially, there may be a wide variation between these figures, and it’s hard to begin negotiations based on what either party thinks the value should be. This is where a business valuation could be beneficial.
Business valuations measure a business’s worth using unique formulas that account for multiple factors. The complexity of valuations is partly due to the number of factors that must be considered, but it is also because the process of valuation can be highly speculative. There is no standard method for valuing a business, but rather multiple methods. The most appropriate method often depends on the type of business and other key financial factors. Value is driven by market forces that may be unknown at the time of negotiations, which may lead to differing opinions between the owner and the potential buyer. Despite this, business valuations are critical during negotiations.
When a business valuation is acquired upfront and used as a starting point in negotiations, both parties may enter the conversation in good faith and with the understanding that the valuation was created by someone with no vested interest in the sale.
Types of Business Valuations
Moving forward with obtaining a business valuation can be daunting. There are multiple types of business valuations, some of which emphasize different aspects of the business than others. It’s good to have an idea of the different methods used before deciding on the most appropriate one for your goals. Five of the most common business valuation methods include:
- Asset valuation: This valuation method accounts for both tangible and intangible assets using book or market value to determine the total value of your business. It includes assets such as cash, equipment, inventory, real estate, investments, options, patents, trademarks, and customer relationships.
- Historical earnings valuation: This method looks at the company’s gross income, net income, ability to pay existing debt, and capitalization of cash flow or earnings. Your business’ value depends upon how well it generates income to cover the existing debt.
- Market value: This method compares other similar businesses with yours. It looks at what these companies have or would have been sold for to determine the relative value of your company.
- Future maintenance earnings valuation: This valuation method is common when profits are expected to remain stable for a company. It looks at future maintainable earnings valuation in relation to the previous years of sales, expenses, profits, and gross profits.
- Discount cash flow valuation: This method is better when profits are not expected to remain stable. It calculates the business’s future net cash flows and discounts them to present-day values. These numbers demonstrate the discounted cash flow valuation and how much money your business assets could make in the future.
Selecting the right business valuation method can help you secure a fair price for your company, as well as help any potential buyers feel like they are getting a fair deal. While many large companies seek business valuations on a regular basis, it is not as common for smaller companies. Conducting a business valuation can be incredibly complex. It is advisable to work with a reputable business valuation company. To learn more about business valuations and how to leverage them during negotiations, contact Shuster & Company.
A full-service Certified Public Accounting Firm located in Denver, Shuster & Company P.C. provides quality, personalized financial advice and guidance to individuals, businesses, and the legal community. We offer an extensive range of services, with emphasis in forensic accounting, business valuation, and litigation support.