How much is your business worth? It’s an interesting question, but one that’s difficult for many entrepreneurs to answer. So many factors define how the value of a business is calculated – both quantitative and qualitative. Businesses aren’t static – they grow and evolve over time, and so does their value.
It’s crucial for business owners to know how to quantify the value of their business. As likely the most valuable asset you own, your business plays a major role in various elements of your life. In this overview, we outline the different valuation services that can be offered when valuing a business and explore the pros and cons of each.
Many entrepreneurs don’t realize there are different levels of service offerings professionals can offer when valuing their business. These services can broadly be divided into two camps: formal valuations and informal valuations. Each has its own benefits and drawbacks, and there are certain scenarios where business owners should use one over the other.
Strothman+Co is an accounting, advisory, and audit firm headquartered in Louisville, KY. Our team specializes in working with entrepreneurs and owners of closely-held businesses, bringing a wealth of knowledge across transaction advisory, business valuations, succession planning, and more. Contact us today to learn more about valuing your business.
What is a Business Valuation?
A business valuation is an independent appraisal that calculates the fair market value of a business. There are a wide variety of reasons to conduct a business valuation, some of which include preparing to purchase or sell a business, gifting of shares, divorce, estate planning, or establishing an Employee Stock Ownership Plan (ESOP).
In essence, a business valuation tells you what your business is worth.
Business Valuation Service Offerings
Business valuation service offerings range from a formal business valuation, called a conclusion of value, which is extremely thorough, to the more informal calculation of value that serves to give owners a quick understanding of their business’s value at a certain point in time.
Conclusion of Value
Common scenarios where a conclusion of value is preferred include the gifting of ownership, estate planning, establishing ESOPs, or divorce proceedings.
Various standards govern how a conclusion of value should be completed. CPAs must follow AICPA professional standards. Other valuation standards, such as the National Association of Certified Valuators and Analysts (NACVA), exist and must be followed if the valuation professional chooses to be a member of that organization .
There are three valuation methods. A conclusion of value must include a description and calculation for each of them.
- Asset: determines a business’s value by adjusting the business’ assets to fair market value and subtracting the fair market value of the business’ liabilities.
- Income: uses a business’s historical or forecasted income stream to determine its value.
- Market: uses the selling price of comparable businesses to determine the value of the business.
Conclusions of value must also include a detailed description of the company, an industry, regional, and national economic analysis, and other requirements as outlined in the standards.
Advantages of a Conclusion of Value
A conclusion of value is an extremely comprehensive approach to valuing a business that incorporates a wide variety of quantitative and qualitative measures to arrive at the value of the business.
Provided the valuation is conducted in accordance with all industry and professional standards, these valuations are accepted by the IRS and the Department of Labor, and tend to be more defensible in court.
Disadvantages of a Conclusion of Value
Due to the level of complexity in obtaining a conclusion of value, these engagements can typically be expensive and time-consuming for businesses. Additionally, they can still be challenged by both the IRS and legal authorities.
Calculations of Value
A calculation of value is similar to a conclusion of value but is less complex. Arriving at a calculation of value is a shorter, less formal process that doesn’t require a complete industry, regional, and national economic analysis, nor is the valuator required to calculate a value under each method.
Entrepreneurs will receive a valuation report signed by the valuator, but a calculation of value will contain the following statement:
“This calculation engagement does not include all of the procedures required in a valuation engagement, as that term is defined in the SSVS. Had a valuation engagement been performed, the results might have been different.”
Calculations of value can be used to guide transfers of ownership, mediate disputes outside of court, and for assigning value to gifts of ownership in a small business..
Advantages of Calculations of Value
Owing to their increased simplicity, calculations of value are much more affordable. They often represent a good starting point for negotiations over the sale or purchase of a business and also help business owners to pinpoint value drivers to focus on to increase the value of their business. For small businesses with positive cash flows, and no reporting requirement to any authority, this method is often a better fit.
Disadvantages of Calculations of Value
A calculation of value lacks the rigor and depth of analysis that is required for a conclusion of value. As such, it is not as complete of an analysis.
Another service offering is consultation on valuation principles and methodologies and how they affect the value of the business.. There is no deliverable report as with the other options.
This consulting engagement can be one-on-one with the business owner or with the entire management team. Depending on the scenario, this type of engagement might be the best fit for business owners who want to have a conversation about how to calculate what their business is roughly worth and understand what drives that value.
Understanding what your business is worth is important – but understanding why it’s worth that much, and how to add value, is perhaps even more important.
Strothman+Co: Strategic Advisory Services for Entrepreneurial Businesses
Obtaining a valuation for your business, regardless of the service level you choose, is a process that yields significant insights. Entrepreneurs can uncover their business’s greatest value drivers and double down on these, while also addressing weaknesses that are holding value creation back. Over time, this helps business owners increase the value of their business, laying the foundation for a successful exit.
Throughout this process, the strategic guidance of an experienced business valuation firm is an invaluable asset. At Strothman+Co, we specialize in providing a wide range of accounting, advisory, and tax services to privately held lower to middle-market businesses.
With experience in capital structure, turnarounds, and change management, our business valuation team doesn’t just tell you how much your business is worth: we partner with you to grow that value over the long term.
Interested in learning more? Contact our Strategic Advisory Services team today.