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Conduct Your Own Business Valuation: 9 Important Considerations

By: Lending Tree

 

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If you’ve ever thought about selling your small business or gifting a percentage of your ownership to the next generation, you need to know what it’s worth. While you might have an idea of what you think your business is worth, a business valuation can give you (and your potential buyers) a more objective and fact-based number.

But how does a business valuation actually work? There are a few different methods — each with its benefits and drawbacks. So let’s look at the different business valuation methods you might consider.

What is a business valuation?

A business valuation is a process of determining the value of a company by assessing different factors, such as assets and liabilities, its place in the market, projected cash flows, and historical revenues.

There are several reasons you might need a business valuation. For example, you might need one to:

  • Establish the fair market value of the company for merger and acquisition purposes
  • Determine the value of a gift of stock or business ownership interests
  • Assess the worth of a business interest during a divorce or other litigation
  • Negotiating with lenders or investors to get funding

Choosing a business valuation method

There are three widely accepted business valuation methods: asset-based valuation, market-based valuation and income-based valuation. Let’s look at how each of those methods work and their pros and cons.

Asset-based valuation

An asset-based valuation approach values the business based on its underlying physical assets. It considers the current market value of the assets and subtracts any liabilities or debts associated with them.

When conducting an asset-based valuation, you need two things:

  1. Assets owned by the business. This includes physical assets such as buildings, equipment, inventory, vehicles, furniture and fixtures, and computer equipment, and intangible assets, such as patents and trademarks, customer lists, and non-compete agreements. You also need to know each asset’s fair market value (FMV). Fair market value isn’t necessarily what you paid for it or the book value shown on the balance sheet — it’s what a third party would pay for the assets under normal market conditions.
  2. Liabilities owed by the business. This includes payables, accrued expenses, unpaid taxes, mortgages, equipment loans, etc.

Once you subtract your total liabilities from your total assets, you have the business value.

Pros of asset-based valuation

  • Easy to understand and explain the results
  • Can provide a quick estimate of value if done correctly
  • Doesn’t require complicated calculations or assumptions about future performance

Cons of asset-based valuation

  • Based only on current values, which may not reflect future earnings potential
  • Can be difficult to determine the fair market value of assets
  • Doesn’t consider the value of a company’s brand, customer loyalty, or other intangibles that are difficult to quantify — all of which can have a major impact on the value of a business

Market-based valuation

The market-based valuation approach looks at recent sales of similar businesses to determine a company’s estimated worth. It considers factors like current trends in the industry and overall economic conditions to determine value.

There are two ways to conduct a market-based valuation. The first is to look at metrics from public companies similar to the business. However, this method is rarely useful for small businesses because publicly-traded companies tend to be large organizations.

Instead, small businesses typically use the precedent transitions method, which looks at recent sales of companies of similar size in the same industry. For example, if you own a plumbing company, you would look at sales of other plumbing companies (or other trade contractors) of similar size.

Pros of market-based valuation

  • Takes into account current trends in the industry and overall economic conditions
  • Can be used to compare your company’s performance against others within its sector

Cons of market-based valuation

  • Requires information on recent sales data from other companies in the industry, which may not be readily available
  • May not take into account the unique characteristics of your business, making it difficult to accurately assess the value of uncommon or highly specialized companies

Income-based valuation

The income-based approach, sometimes called the earnings-based approach, uses a company’s historical financial performance, such as its profits and cash flow, to determine its value.

There are two ways to perform an income-based valuation.

  1. Discounted cash flow (DCF) method. Under this method, you prepare a cash flow forecast for a certain period (usually five years), then adjust those cash flows for the time value of money and risk.
  2. Capitalized earnings method. This method involves taking the company’s historical net profits and multiplying them by a capitalization factor to find the present value. This method assumes that a company’s future performance will be based in part on its past performance.

Pros of income-based valuation

  • Takes into account a company’s historical financial performance to determine its value
  • More reliable for established businesses with steady income streams from operations

Cons of income-based valuation

  • Not suitable for businesses that are still developing or those with volatile income streams
  • May not take into account current trends in the industry

Can you conduct your own business valuation?

It’s possible to calculate the value of your business on your own (depending on your level of expertise and experience) if you just want an idea of how much your business might be worth.

However, if you need a business valuation because you’re buying a business, selling a business, or gifting a percentage of your ownership to someone else, it’s best to seek professional help.

Another person or entity interested in buying your business will likely want a formal valuation performed by a third party. And if you’re gifting a portion of your business, you may need to file a gift tax return to report the value of the gift to the IRS.

Professional valuators are typically well-versed in different valuation techniques and can advise you on the best approach to use when assessing the value of your business. They also have the knowledge and skill to accurately assess the value of your business based on the most up-to-date industry data, such as past performance and future prospects.

How to find a business valuation specialist

The best way to find a business valuation specialist is to ask other business owners or contacts in your industry for recommendations. Your accountant or attorney may have suggestions as well.

You can also look at organizations that license or certify business valuation specialists. These organizations often have website directories to help business owners find local professionals. Some organizations to consider include:

Once you have identified some potential candidates, do your research to ensure they’re licensed or certified and have experience performing business valuations. Check out their track record by asking for references. Discuss their fee structure so you know how much your business valuation will cost, how long it will take, and what information they’ll need from you to complete the work.

Valuing your business can be complex, but understanding the different methods available can help you decide which is best for your situation. Professional valuations offer more reliable and accurate results, so for most business owners, that’s the best option. However, if you prefer to do it yourself, there are resources and tools out there to help.

Whatever method you choose, it’s important to remember that the most accurate idea of your business’s worth comes from potential buyers and what they’re willing to pay.

Published: June 13, 2023
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Lending Tree

LendingTree is an online loan marketplace for various financial borrowing needs including auto loans, small business loans, personal loans, credit cards, and more. We also offer comparison shopping services for autos and educational programs. Together, these services serve as an ally for consumers who are looking to comparison shop among multiple businesses and professionals who will compete for their business.

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