Accurately Estimating the Value of Your Business is Important
Accurately estimating the value of your business is an important life step. Here to answer some common questions about this process is Greg Feucht, CPA and CVA (Certified Valuation Analyst).
Q: Many business owners understand the need for a business valuation—“someday.” But are there situations making it necessary to do a business valuation immediately?
The death of a business owner is one example. If the business is going to be inherited, we’d want to know the value of that business for the estate. The heirs would be allowed a step-up in basis to fair market value. If the value of the business is large enough, there could also be estate tax implications. An owner’s death may also be a triggering event of a buy/sell agreement. This agreement may require a valuation to determine the value for payment to their heirs.
In divorce or marital dissolution cases involving a business, part of the settlement could mandate an immediate valuation.
Q: Why should business owners invest in knowing—and, more importantly, understanding—the value of their businesses?
There are a number of situations where lacking this knowledge could leave the owner unable to make an informed decision.
Suppose an owner has no plans to sell the business, but someone comes along and makes an offer. Is the offer realistic? Fair? An owner who knows the business’ value, and has it credibly documented, is in a better position to know when an offer is reasonable.
If an owner considers converting the business from a C corporation to an S corporation, a business valuation prior to conversion could be very helpful. The value of tangible and intangible assets is needed to document any potential built-in gain tax that may be realized if assets are subsequently sold.
An accurate business valuation is important to keep shareholders informed, in succession planning, and for planned business expansions. A bank may be more willing to finance an expansion when a business valuation is already completed.
Understanding the factors affecting a business valuation can help raise an owner’s awareness regarding the management of that business.
Q: Is there a standard method you use during business valuations? Or is each case unique, unlike any other?
There are three standard methods used for a business valuation: The income approach, the asset approach, and the market approach. A valuation considers and evaluates each of the approaches, although each approach may not be used in the final conclusion of value.
Many, diverse factors go into a valuation. Although there are general procedures for each valuation, each engagement needs to be specific to the business. Even in comparing very similar businesses, there are differences in management styles, in customer base, and a host of other considerations. Three different machine shops could exist on the same street, each serving its own unique niche.
Q: What key factors help increase the value of a business? Cash flow? Management? Inventory?
Management is a key factor. For instance, if the owner is the only manager, and is not interested in staying on if the business were to be sold, much is lost when that owner leaves. In contrast, for a similar company having a great depth of management, and its procedures well-documented, a potential buyer could be able to pick this business up and transition into its operation fairly smoothly.
Turnover is a factor. High turnover can result in less familiarity with policies, procedures, and the inner workings of the company.
Good, consistent cash flow is a great way to increase the value of your business. A potential buyer wants to know what kind of return on his investment he can expect from that business.
Concentration is another factor to consider. Having customers limited to a very narrow niche might be less attractive than having a diverse range of products and number of customers.
While the factors given above are considered, keep in mind that each business is unique, and that each factor will affect a given business in different ways or to different degrees.
Inventory is not necessarily a major factor in a valuation. It may be an important part of the balance sheet but an investor would prefer cash or assets that have more liquidity. Inventory can be obsolete or difficult to sell which can decrease its value.
Q: How much does a business valuation typically cost?
That varies greatly, depending on the size and complexity of the business. A smaller business can cost three to five thousand dollars, while some larger public companies can run in the twenty to thirty thousand dollar range.
Greg Feucht earned a BS in Accounting from Marian University. He is a Certified Valuation Analyst. Greg joined Huberty CPAs & Trusted Advisors in 1999.