Valuing Your Business
Most owners seek a business valuation when they’re looking to sell their business, but there can be many other reasons to learn what a business is worth:
- Buy/sell transactions between business owners may require a current valuation.
- A business may be seeking to purchase minority shareholder interests or setting up an Employee Stock Ownership Plan.
- An owner’s divorce, retirement, or death.
And of course, an owner may just want to know a fair price if an offer came along.
How do you determine what a fair price would be? According to IRS Revenue Ruling 59-60: “The fair market value is the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”
If that definition seems a little vague, the IRS offers more concrete factors to consider in establishing fair market value estimates:
- the nature of the business and its operating history;
- the industry and economic outlook;
- the book value and financial condition of the company;
- the company’s earnings and dividend paying capacity;
- the value of the company’s intangible assets, such as goodwill;
- transaction prices of other companies engaged in similar lines of business.
Valuation methods
There are several ways to determine a fair price for a company. The method chosen will depend on the reason for the valuation and the company’s own specific situation. For example, a business may be valued simply at its net asset value (assets, including cash, accounts receivable, inventory and equipment, less liabilities). Usually, this appraisal method results in the lowest valuation of the various methods.
The comparables approach is similar to buying a home. The appraiser looks at the selling price of similar businesses to arrive at a valuation. The income approach is the most complex and usually arrives at the highest value. In the discounted cash flow method, companies can be valued based on their future cash flows. This detailed analysis depends on accurate financial projections and discount rate assumptions. A simpler approach is the single period capitalization of earnings. Revenues for some previous period (such as the last three years) are multiplied by a factor that differs from industry to industry and business to business. In an industry where typical valuations are two times earnings, the value of the business might be equal to twice the average annual revenues over the previous three years.
Together with an analysis of the company’s operating history, business, industry and competitive environment, the results from one or more of these valuation methodologies are combined to form the basis of a comprehensive business valuation. Some business owners ask their accountants for help with appraising the business. Others turn to professional business appraisers, who may be more knowledgeable about buying and selling practices in their industry.
If you are negotiating to sell your business, one common device to match buyer’s and seller’s expectations is to set up an earnout schedule. With earnouts, the price of the business is contingent upon future earnings. Both the buyer and the seller must settle on the terms of the earnout, such as how profits are to be determined, dispute resolution and maximum payment.
For more information about valuing your business, you should seek the advice of your lawyer and accountant or a qualified business appraiser.
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AXA Advisors, LLC does not provide legal or tax advice. Please consult your tax or legal advisor regarding your individual situation.
Dan Halos offers securities through AXA Advisors, LLC (member FINRA, SIPC) 10500 NE 8th Street Suite 1600 Bellevue, WA 98004 and offers annuity and insurance products through an insurance brokerage affiliate, AXA Network, LLC and its subsidiaries.
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