Q&A: Understanding Business Valuation in a Changing Landscape

In recent years, business valuation experts have navigated an evolving landscape marked by new standards, technological advancements, demographic shifts, rising interest rates, post-COVID inflation, and tax code changes. Business valuation is a formal process aimed at estimating a company's intrinsic value, combining both art and science. This endeavor requires the expertise of seasoned analysts who meticulously evaluate a myriad of factors, ultimately leading to a comprehensive assessment of a business's worth.

Why Consider a Business Valuation?

Even if you are not currently considering selling your business, there are several compelling reasons to obtain business valuation services. The most significant factor is the unpredictability of life. Should unforeseen circumstances arise, having a credible business valuation becomes essential for determining an asking price and facilitating negotiations. Other reasons to consider a business valuation include:

• Unforeseen health issues
• Estate and retirement planning
• Financial assistance needs, such as debt financing, bankruptcy, or expansion funding
• Internal matters, such as employee share purchases or implementing equity-based compensation programs
• Litigation, including marital dissolutions or shareholder disputes.

A comprehensive company valuation provides insights into financial health, growth prospects, and overall worth. Different valuation methods exist, including discounted cash flow, comparable company analysis, and asset-based valuation; the choice of method depends on the context and purpose of the valuation.

What are the Key Considerations When Hiring a Business Valuator?

1. Credentials: Look for professionals with recognized certifications such as Certified Valuation Analyst (CVA), Accredited Senior Appraiser (ASA), or Accredited in Business Valuation (ABV). These credentials indicate the necessary training and experience for delivering a reliable valuation.
2. Experience: Select a valuation firm with a track record of valuing businesses similar to yours. This ensures they possess the necessary knowledge and expertise to accurately assess your company's value.

Is there a Rule of Thumb or Industry Multiple? 

Many times, business owners in well-established industries rely on a standard multiple, or “rule of thumb”, that dictates that businesses in their industry always sell for two times annual revenue (the revenue multiple); so, they naturally ask why they should pay someone to value their business? These rules of thumb are used by business brokers, the individuals who often facilitate small private business transactions, and represent median multiple values. In reality, the multiples cover a wide range of value, and the median value is just a convenient midpoint and does not represent the revenue multiple for any actual transaction. Unless your firm is truly a median firm, then using the industry rule of thumb for this purpose is clearly wrong. You’ve put a lot of hard work into making your business be the best that it can be, why accept only a mid-point valuation?

What is the difference between Investment Value vs. Fair Market Value?

Investment value and fair market value are two terms that can be used when evaluating the value of an asset or entity. Both terms are used regularly in financial analysis and may have different meanings depending on the scenarios in which they are used. Investment value and fair market have distinct implications:

• Investment Value: This term often encompasses a broader range of values derived from various valuation methodologies. It may include synergies between a specific buyer and seller, such as a premium that a competitor might be willing to pay to acquire your company and its customer base.
• Fair Market Value: This reflects the market value of an asset or entity, adjusted for the specific circumstances of market transactions. It is commonly associated with definitions set forth by accounting standards and is frequently utilized in formal appraisals for IRS purposes related to gift and estate tax rules. Fair value and fair market value are also applicable in litigation contexts, influenced by the case type and jurisdiction.

What are Tangible vs. Intangible Assets in Business Valuation?

Assets are investments that enhance a business's value, categorized into tangible and intangible assets: There is one significant difference in tangible vs. intangible assets, and that lies solely on whether or not they physically exist. Scratching your head? Let’s unpack the definition of tangible assets and intangible assets. 

Tangible Assets: These are physical items with value, including:

• Land
• Real estate (buildings)
• Machinery and equipment
• Inventory
• Securities and cash

Intangible Assets: These are non-physical assets that contribute to a business's value. Collectively referred to as "blue sky," examples include:

• A positive business reputation
• Customer relationships and customer lists
• Well-known trademarks or branding
• Industry experience
• Established partnerships
• Intellectual property, such as copyrights and patents
• Minimal owner risk, indicating that the business can operate independently of its current owner

The context of a business sale—whether voluntary or forced—can also impact intangible assets' valuation.

How do I Prepare for a Favorable Business Valuation?

Did you know you can prepare for your commercial business valuation, and help the process move smoothly and efficiently? While preparing for a positive valuation technically starts at the beginning of the business’s existence, it carries on with each passing day. Business owners can take proactive steps to facilitate a smooth and efficient valuation process:

• Review Your Business Plan: Regularly update your business plan to reflect your goals and strategies. A well-documented plan can demonstrate your business's success to potential buyers or investors.
• Maintain Up-to-Date Financial Records: Ensure your financial statements, including profit and loss records, balance sheets, tax returns, and future projections, are organized and accurate. Identify any potential non-operating or discretionary expense items. Clear documentation will aid the valuation process.
• Minimize Liabilities: Reduce risks by diversifying your customer base, implementing sound processes, and safeguarding confidential information.
• Reduce Debt: Paying off outstanding debts can enhance your business's valuation, especially in a voluntary sale scenario.

Can I Estimate My Business's Value Independently?

While business valuation is a critical process for owners in the lower to middle market, it is complex and involves extensive analysis. A comprehensive valuation may encompass over 60-100 pages of narrative analysis and multiple methodologies. By obtaining an accurate valuation, business owners can make informed decisions regarding their company's future.

Conclusion

Key takeaways from the valuation process include:

1. Critical for Determining Worth: Understanding your business's value is essential for estate planning, potential sales, divorce proceedings, and partnership disputes.
2. Complex Process: Valuation involves assessing financials, growth prospects, market conditions, and other influencing factors.
3. Various Approaches: Common methods include the income approach, market approach, and asset approach.
4. Future Cash Flows: The income approach focuses on projected future cash flows.
5. Comparative Analysis: The market approach compares your business to similar entities recently sold.
6. Asset Valuation: The asset approach totals your business's assets minus its liabilities.
7. EBITDA as a Metric: While EBITDA is useful for understanding operating performance, cash flow is the key measure in professional valuations.
8. Tangible and Intangible Assets: Both types of assets play a vital role in determining overall value.
9. Value Fluctuations: External factors can influence a business's value over time.
10. Professional Expertise: Engaging an experienced professional is crucial for an accurate business valuation.