All businesses have one common feature. They are run by people, as in structural objects, people are open to many elements that can affect their daily routines. Part of those daily routines includes running their business. What if something happened that altered that daily routine? What if you had to make a quick decision regarding the future of the company? Do you sleep well knowing you could one day make a rash decision which could prove costly only because you where not adequately informed of the value of your business? In order to succeed in business, one should strive to be proactive versus reactive. Having a business valuation done and on hand can only help business owners understand what they are worth. Having it documented goes above the just knowing by providing leverage if and when the need ever arises to make a quick business decision when suddenly faced with a personal or business life changing event. This article will cover the methods used to value a business, why a valuation should be completed and how to get it done. At Innovative Financial Group – Atlanta, we are a full service independent financial services firm that works with business owners on this subject as well as many other areas of concerns.
The first place to start is how a business is valued. The following information is a very high overview of each method and which industries fit best with each.
Generally there are 3 approaches to valuing a business, Assets Approach, Market Approach and Income Approach. Since no one method is appropriate for valuing every business, it’s common to reference each of the three methods in the valuation. Depending on the industry and makeup of the company will determine which method is best to use.
Asset Approach – This approach is used with businesses that have tangible assets such as inventory and equipment or if a business has substantial fixed assets.
Market Approach – This approach uses like businesses that have recently sold. This could be challenging if a similar business can’t be found.
Income Approach – This approach uses prior earnings to estimate the business value based on future earnings potential. Within this approach, there are 4 methods used –
- Capitalization of Earnings –
- Business with few tangible assets such as consulting use this method
- Excess of Earnings –
- Business with significant assets such as manufacturing use this method
- Discounted Cash Flow –
- Business that deal with mergers and acquisitions use projected future earnings that are discounted.
- Multiple of Discretionary Earnings –
- Business in the service oriented field such as legal, accounting, healthcare, etc. use this method. Goodwill of the owner will have an impact of the value.
Benefits of a Valuation
Now that we know the methods and approaches, let’s answer the next question, “Why?” Besides the obvious of knowing what your business actually is valued at, other benefits include
Business insurance – Knowing the value will help figure out how much coverage is needed for
- Key Person and Buy/Sell
- General Liability
- Workers Compensation
- Property and Liability
Succession Planning – Knowing the value will help with planning for the future and transitioning the business to the next generation or an outside buyer
Getting a Valuation Done
There are several ways to accomplish a valuation. The first way is to hire a certified company that specializes in this field. It is important to get a company that has experience in the industry of your business. The cost will vary depending on stability of industry, years the company has been in business, good records, etc. If you are actually selling the company or if there is a dispute with a business partner on value, using this form would make the most sense.
A second way is to get an informal valuation done. Several insurance carriers offer this “informal” valuation. They request several years of tax returns and a short questionnaire. They use the information and compare the methods and approaches listed above to get to an informal valuation. Companies who are looking to get a buy/sell agreement in place or updating the agreement to ensure the valuation meets the verbiage in the agreement.
At the end of the day the value of the company is what a willing buyer will pay and a willing seller will sell for. But knowing the value will give each party a starting point. If we can be a resource or answer any questions, please connect with us at www.ifgatl.com