What is a Business Valuation? (And Which Type Is Right for You)
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Okay, so you may be thinking, “Everyone knows what a business valuation is.”
It’s a report done to determine what the value of a business is, right?
Yes, but play along for a second.
- Thinking of selling your business?
- Wanting to focus your energies to grow your company’s value?
- Transitioning the business to family members or other partners?
- Taking on new partners and need to determine buy-in price?
- Retiring and considering an exit strategy?
Hint… it’s not a good idea to get the same type of business valuation to sell your business that you would if you were headed to court to fend off an angry business partner.
Why? Let’s talk about it.
What Exactly Is a Business Valuation?
A business valuation is the process of determining the economic value of a company or business unit.
But, a business valuation can be performed for a variety of reasons, including a sale, establishing partner ownership, taxation, and divorce proceedings.
While all valuations are created with a similar set of criteria, they differ based on the context they’re being evaluated within.
In other words, the value of your business depends on the reason for the valuation. Sounds crazy, I know.
The Two Primary Types of Business Valuations
We’ll break it down in a way that makes it easy to understand the type of valuation you’ll need.
The main types of business valuations are:
- Legal Valuations
- Fair Market Valuations
This type of valuation uses primarily quantitative methods to analyze 5-8 years of your company’s history. These valuations can be used in court to support the value in a variety of cases. To get a legal valuation for your company, you will need a certified appraiser or a professional certified in legal valuations.
This kind of valuation can cost up to $60,000 and is usually not an accurate representation of what your business would sell for since it does not look at your business the way a buyer would.
Fair Market Valuation
This valuation employs more qualitative methods, analyzes around 2-3 years of financials, and can be used to sell your business in the current market. The best professional to perform this type of valuation would generally be a broker or a mergers and acquisitions advisor (M&A advisor).
Brokers and M&A advisors will use the Buyer Test Method to sanity check the value of your company in the context of what a buyer would be able to pay for it. This type of valuation can be free or cost up to $15,000 depending on who you have perform the valuation.
Reasons For a Business Valuation
Based on your needs, you’ll want to use one valuation type over the other. For instance, if you’re unfortunate enough to be going through a divorce, you’ll need a legal valuation. However, if you’re planning on selling your business, you’ll want to get a fair market valuation.
- Litigation: This applies to any type of legal proceeding. Examples include divorce, lawsuits, or partnership disputes. Methods used in previous court cases will affect the valuation techniques that can be used in legal valuations.
- Exit Planning: Whether you’re thinking of selling in the near future or several years from now, you should have a good understanding of what your business is worth. If you’re like most business owners, your business comprises a large amount of your net worth. It makes sense to have a realistic view of what you would receive when you decide to (or are forced to) sell. You’ll also want to work with your CPA to understand your estimated tax liability.
- Buying or Selling a Business: When you know you want to sell your business, getting a business valuation is the next clear step in selling your company.
- Tax Planning: You may want to get a business valuation to assess the value of your company to gauge how much you will have to pay in taxes when it finally comes time to sell.
- Funding: If you don’t plan on selling, but instead want to determine the value of your company to increase its value, that is an option as well. A valuation can help show potential investors what your company is worth.
When you are planning on getting a business valuation for any of these reasons, you should speak to a trusted advisor about the right type of valuation for you. The type of valuation you will need can vary and will impact your success.
Who To Hire and The Questions to Ask
The best advice I can give is to choose a professional that performs business valuations frequently. While most professional advisors will quickly nod and say “Sure, we can do a business valuation,” you would be wise to ask a few questions first.
Professionals Who Perform Valuations
Regardless of the type of valuation you need, it is key that you get a business valuation performed by someone who is certified to perform valuations and has years of experience performing them.
- Business brokers
- M&A advisors
Out of appraisers, business brokers, and M&A advisors, M&A advisors typically perform the most business valuations. However, you may come across an attorney or CPA that performs valuations often as well.
The benefit of enlisting a quality M&A advisor or business broker to perform a valuation is they have direct experience in selling companies and thus should have a good understanding of what a company can actually sell for in today's market.
Questions to Ask Valuation Specialists
If You Are Buying/Selling a Business or Need Funding:
- How many valuations have you performed in the past year?
- How many businesses have you sold, and how close to the valuation price?
If You Are Involved In a Legal Proceeding:
- Have you performed valuations used in court before?
- Will you testify in court if it comes to that?
- Are you familiar with IRS Ruling 59-60 and USPAP valuation standards?
If You Are Exit Planning or Tax Planning:
- Do you provide context in your valuations so business owners can take steps to improve their business value?
Get The Correct Business Valuation For Your Needs
Getting a professional business valuation is a good way to learn the value of your company and get started on the next step of selling your business or continuing on in your legal proceeding.
Some firms perform both fair market valuations and legal valuations, making them a great resource at determining which valuation is right for you.
Legal valuations will be lengthy and written in legal language, whereas a fair market valuation will be written with general wording and will be considered in the context of the current business market.
At MidStreet Mergers & Acquisitions, we are certified to perform both types of valuations and primarily perform fair market valuations for our clients that want to sell their business. To view a sample valuation or receive a valuation for your business, contact us today.