Why Business Valuation Is Important

Every business needs a business valuation updated periodically. Unfortunately, many business owners don’t understand the importance of business valuation, and they never really think about it. 

According to a recent CNBC report, up to 98% of small business owners don’t know the value of their company. These business owners face a significant disadvantage for various reasons.

Read on to learn the importance of business valuation, the reasons for it, and the benefits of having an updated professional valuation on hand.

What Is Business Valuation?

A business valuation refers to a professional, independent appraisal that measures your company’s worth. Business valuation experts complete the assessment in different ways to arrive at a specific value or an informed ballpark range.

Many business owners quote a value off their heads when thinking about how much their business is worth. However, they often find out that they either overvalue or undervalue their business after a professional evaluation.

The Major Approaches for Business Valuation

When it comes to value assessment in business, valuators can use different approaches. Factors that determine the approach they’ll settle for include the industry, your business’s development stage, the reasons for the valuation, and more.

All the possible valuation models fit into three main categories:

The Income Approach

In the income approach, the valuators use a discounted cash flow analysis to determine the present value of your company by looking at the estimated future cash flow.

The valuators estimate the future cash flow by looking at the company’s historical performance and future growth opportunities, in line with possible risk factors.

The Market Approach

With the market approach, the valuators look at acquisitions of similar companies in the same industry with a focus on their deal multiples. These include price-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) and price-to-earnings.

The Adjusted Balance Sheet Approach

This approach involves re-evaluating assets or liabilities on the brand’s balance sheet based on the fair market value. Valuators often use this option for holding companies or early-stage ventures.

Variations of the income and market approach or a combination of both work best for the valuation of most businesses. Applying multiple feasible methods is the best way to arrive at an accurate value for any business.

Top Reasons for Conducting Business Valuation

The importance of business valuation cannot be overstated. Without an accurate valuation, it’s harder to make informed business decisions. Business valuation also aids in a range of legal situations.

Some of the most common reasons for conducting business valuation include the following:

  • Exit strategy planning. Are you planning to sell your business? The valuation can give you an idea of how much the business is worth. It can also highlight the need to implement strategies that will help improve profitability prior to the exit.
  • Setting up buy/sell agreements. A buy/sell agreement in a partnership or LLC helps prevent disputes down the line. A valuation can provide a starting point for the agreement.
  • Settling partnership or shareholder disputes. An independent business valuation is necessary when needed to settle ownership interest.
  • Processing mergers and acquisitions. Some businesses grow by buying up or merging with other companies. A business valuation will help determine if the ascribed worth of a business is genuine.
  • Working out the share value of an employee stock. The Internal Revenue Service (IRS) requires an expert to evaluate the shares of employee stock ownership plans every year to establish a fair stock price.
  • Securing funding. An objective valuation aids in a negotiation with banks, and other prospective investors. The value of the business is usually the first thing they ask about before continuing discussions.
  • Estate planning. Proper estate planning will help your heirs avoid a heavy tax burden on an undervalued business. Proper business valuation can help establish a fund for future estate tax liability.
  • Gift tax planning. A documented, defensible, and accurate value of your business can help you avoid problems with the IRS.
  • Divorce settlement. The significance of business valuation makes it a requirement in most cases of divorce settlements. The equitable division of assets requires the documentation and valuation of all business interests for the parties involved.

The Benefits of Business Valuation

Some of the benefits of business valuation include the following:

More Insight Into Business Performance and Growth

As a business owner, a business valuation will help you understand how well your business is doing compared to others in your industry.

Since a valuation looks at data like assets, bank account balances, liabilities, projected earnings, and more, it enables you to gauge the financial health of your business and also measure its performance objectively.

You can see whether you should maintain the current trajectory or explore other ways to boost profitability and, by extension, the value of the business.

The impact of business valuation has helped many businesses go from underperformance to becoming robust.

A Peek Into the Company Sale Value

Are you considering selling your company? A business valuation can give you an idea of how much you can realistically expect to sell. Knowing the value of your business will help you enter negotiations on a strong footing when the time comes.

Similarly, if you’re on the other end of the table during an acquisition, the valuation will ensure you negotiate from a knowledgeable position.

A Deeper Understanding of Company Assets

Most valuations will take a deep dive into the assets of your company, giving you a clear, actionable insight into your holdings. Many business owners have an estimate of how much their assets are worth. However, they often fail to look beyond physical assets.

Evaluating elements like intellectual property can significantly boost the valuation of your business.

More Access to Investor Funding

Potential investors tend to fund companies that have a defensible business valuation. They will want to see how their investment can help push the company’s growth. The growth projections will show them if the investment is worth making or not.

More Strategic Tax Planning

Understanding the value of your business can help you implement some tax-minimizing strategies. When you know the value of your business, you’ll find it easier to plan for capital gains tax, gift tax, and estate tax. A valuation report from a qualified professional can help you lower your tax burden.

Better Insurance Decisions

When you know the value of your business, you can easily work out the right amount of insurance coverage you need. The valuation can also help you decide on the type of insurance policies to go for.

For example, if the business valuation shows a lopsided dependence on you or a partner, it might be beneficial to take out an insurance policy. Similarly, a business that’s at risk of interruption due to geopolitical or climate-related events needs business interruption insurance.

Generally, accurate valuation can help ensure you have sufficient coverage in the event of unforeseen circumstances.

Stronger Support During Litigation

A valuation report is a valuable piece of evidence to have when your business becomes embroiled in a legal dispute over a lost business opportunity or a breach of contract.

With the valuation, your legal representatives can accurately establish the damages incurred due to the contractual breach or due to the lost business opportunity.

Get Professional Business Valuation From Murphy Business Brokers

Looking at the importance of business valuation, it’s crucial to work with experienced professionals to ensure you arrive at a value that gives an accurate representation of the state of your business. At Murphy Business Brokers, our professional crew understands business valuations for diverse industries.

We help business owners arrive at a defensible valuation after assessing tangible and intangible assets, liabilities, and more. Are you thinking about a merger or acquisition? Our services also include helping potential buyers and sellers through the process.

Call our office in Sacramento, CA, today to schedule a consultation.

More About Terry:

Buying or Selling a business can be a stressful and often confusing process. As a business broker, I bring years of valuable, personal experience to help you through the process. For my buyers and sellers, I provide professional valuations, confidential listings, automated buyer inquiry systems, and stay in touch throughout the entire process with regular check-ins. By keeping an eye on the goal, the successful transfer of a business, we will work together to make it happen as quickly and smoothly as possible.

 – Terry J. Watts

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