So you have probably heard of business valuations. If you have, you might have also heard that there are two types - fair market valuations and legal valuations.
The key difference is that one will help you sell your business, while the other one will help you defend your business’s value in court.
It is important that you get the right one for your purposes since they employ different methods.
At MidStreet, we perform fair market valuations for business owners who want to sell their companies. This valuation helps them understand the value of their business in today’s market.
To give you an idea of how the fair market valuation works, we will cover what it is, who performs it, how it determines the value of your business in the context of selling, as well as the difference between it and a legal valuation.
What is a Fair Market Valuation and Who Performs Them?
A fair market business valuation is performed to find the fair market value of your business in the current market. It will ultimately compare the risk and value of your company in relation to similar companies that have been sold.
Valuation specialists, merger & acquisition (M&A) advisors, and brokers will usually use SDE or EBITDA to value lower middle-market businesses ($5-$50 million in revenue). They may also compare the SDE or EBITDA against other valuation methods, such as the buyer test method or discounted cash flow.
The amount you multiply the business’s EBITDA and SDE by considers both risk and value. Things like risk, synergies, and customer quality can impact the amount of the multiple you apply to your business.
The purpose of the fair market valuation is to give business owners an accurate idea of what someone would pay for the company. When you list your business, you sell it for what buyers are willing to pay for it.
How Does a Fair Market Valuation Find The Value of My Business?
As we mentioned earlier, the fair market valuation may employ one of the valuation following three methods, or a mixture:
- Multiple of Earnings (SDE or EBITDA)
- Buyer Test Method
1. Multiple of Earnings in a Fair Market Valuation
The multiple of earnings method will use a multiple or EBITDA or SDE to find the value of your business. To determine which to use, valuation specialists will usually consider the size of the business, the type of buyer you plan on selling to, and how involved in your business you are.
If your business is under $1 million in earnings, you plan on selling to an individual buyer, and you are heavily involved in the business, you will most likely use SDE for the valuation.
If your company is over $1.5 million in earnings, you want to sell to a private equity group (investor/ financial buyer), and you have a manager in place, you will likely use EBITDA in the valuation.
2. Buyer Test Method in a Fair Market Valuation
The buyer test method is used to determine what a buyer could realistically pay for your business. This method will take into account the purchase price, the loan payments, working capital, SBA fees, and down payment.
These things will then be compared to a debt service scenario that considers the SDE of the company, how much you have to pay on the loan and rent (or real estate), and your personal bills.
Want to try out the buyer test method?
Download Our Sample Buyer Test Method Calculator
By using this method, the valuation specialist will be able to find the estimated financial benefit for the buyer purchasing the business.
The Difference Between a Fair Market Valuation and a Legal Valuation
There are distinct differences between legal valuations and fair market valuations, which is why it is important that you pick the correct one for your situation. The legal valuation uses quantitative methods of valuing, while the fair market valuation uses qualitative methods.
Legal Business Valuation
The legal business valuation will generally be more expensive (up to $60,000 depending on the size and complexity of your books and records) and serves to support the value of your business in court. It is not a good representation of what value your business would sell for. It is primarily used for:
The person who performs this valuation needs to be a certified appraiser or be certified in legal valuations.
Fair Market Business Valuation
The fair market valuation is usually less expensive than a legal valuation and will usually range from $0 to $15,000. This valuation can be used for:
- Exit planning
- Tax planning
- Purchasing a business
- Selling a business
It is the best valuation to get if you want an accurate representation of what your business would sell for.
Get a Fair Market Valuation of Your Business
Now you know that if you are planning on selling your business and you don’t plan on entering a lawsuit or getting a divorce beforehand, you should get a fair market business valuation performed.
In order to further understand how the fair market valuation works, you will need to understand SDE and EBITDA. To learn more about these valuation methods, read “SDE vs EBITDA: What's the Difference?”
Learning how to determine the exact value of your business on your own can be tough. If you are thinking about selling your business and want to learn its value, reach out to us today to receive a free business valuation.