Understanding a Business Valuation
Understanding a Business Valuation
Business valuation is a critical step for any organization and is essential as you prepare for what’s ahead. There are things like regulations, finances, and growth issues that can make it hard to understand what a company's true value is. Knowing the value of your business is critical to acquisitions, exit planning strategies, and the overall health and wellness of a business.
In simple terms, a business valuation is a process of developing and determining the economic value of a business (or a set of assets), giving owners an objective estimate of the value of their company. Valuations are used in a variety of circumstances and purposes, including to determine the value for a buy-sell transaction, for tax purposes, to establish partner ownership, or even marital dissolutions. Arriving at a value begins with the subject company’s financial information, including financial statements, tax returns, projections, and business plans, among others. Nevertheless, a detailed and comprehensive valuation goes beyond the ordinary numbers and includes management interviews, site visits, and a thorough evaluation of the nonfinancial aspects that may impact value.
A business valuation is composed of a series of considerations from the valuation expert such as the determination of the standard and premise of value. As stated by the National Association of Certified Valuators and Analysts (NACVA), the term value means different things to different people. This presents a challenge to the expert who has the important task of working with clients to come up with an appropriate definition of value for a specific valuation. Our valuation experience has taught us that the fair market value and going concern are the two (2) most widely recognized, used, and accepted standard and premise of value. In plain terms, the fair market value and going concern premise represent the price at which the subject interest, assuming its continued operation and use of the existing assets, would change hands between a willing buyer and a willing seller.
Besides the selection of the standard and premise of value, the valuation expert must determine the valuation approach and method to be used. Since every business has its own distinctive characteristics, there is no “perfect” method that will result in the only valid and justifiable value. For this reason, there are three primary approaches that a business valuation expert must consider during a valuation process: the Income Approach, Market Approach, and Asset Approach. Each approach is composed of multiple methods that can be used in the determination of value of a business. The approach and method that the expert chooses in a specific situation depends on careful consideration of all relevant information and circumstances of the subject being valued.
Finally, after the expert determines a value, they must consider whether a discount should be applied, such as a discount for lack of marketability and/or discount for lack of control. Experts will frequently apply a discount to privately held companies as they do not have an open market to be traded and are not as marketable as publicly traded entities. Similarly, investors are less probable to pay as much for a non-controlling interest than they would for an interest that allows them to control the entity.
Here at On Point Strategy LLC (“OPS”) we have licensed professionals, Certified Valuation Analysts® (CVA), who can guide you through the valuation process and help you fulfill your business needs. If you would like to find out more information about the OPS way of providing business valuation services, visit https://www.opspr.com/bv1 or contact us at 787-766-6100.
