When do I need a business valuation? Why is it important?
A business valuation is important because it accurately determines the value of your company by using sound principles. An independent valuation professional can establish your company’s worth by applying one or all three valuation approaches – the asset approach, the income approach, and the market approach.
The exact benefits of a valuation may vary based on the situation you find yourself in. And even if you think you know your business inside and out, a valuation adds security, confidence, and insights to any decision you make for the good of your business.
Now, when should you have a business valuation done? When is the right time? When is it most beneficial? Here are 10 common business scenarios you shouldn’t face without a current, objective business valuation.
1. Selling, merging, or buying a business
If you’re selling or merging your business, you MUST have a business valuation. It may be obvious, but it’s a massive advantage when it comes to negotiating and striking a fair deal.
As the seller, you can use your valuation to make sure you’re not hitting the market too high. If your listing is high, your business could take longer to sell and go through multiple price drops. You could turn away qualified buyers who submit an offer that’s less than your inflated price.
And, you don’t want to devalue your business and undersell it. After all, you’ve worked so hard to get to this point. A valuation gives you the ability to make a strategic sale for yourself and the business. No worrying about whether or not you got a fair price or made the right choice!
If you’re on the buying side, you’ll have a better idea of the company’s current state and its future. It can give you more confidence about your purchase and establish trust with the seller. A good relationship with the seller could be an asset if you’d like them to stick around as a consultant.
2. Developing your succession plan
A succession plan isn’t a retirement plan. It could mean restructuring your business, closing it, or selling. If you have an up-to-date valuation in your back pocket, you can create a more strategic and well-informed action plan.
In the years leading up to your exit, you can use insights from your business valuation to increase your company’s value. And subsequently, you could increase your retirement package. A valuation enables you to make improvements now to benefit you in the long run. And, it provides more clarity on the value of your retirement portfolio so you know if you’re on track to meet your retirement goals.
If you’re going through a divorce and begin dividing personal assets and liabilities, your business will likely be part of this process. As a business owner, the value of your interest in the company will be considered an asset. Your spouse could be entitled to half of this value. You’ll want to know the current value of your business so that assets are properly split.
Now, if you’re thinking, “I’ll skip the business valuation because I want my ownership interest to be as low as possible” stop right there. Skipping the business valuation doesn’t ensure a lower value. Using a simplified valuation method such as a “rule of thumb” could result in a higher valuation.
Valuation professionals consider many factors in their valuation – liabilities, intangible and tangible assets, potential cash flow, etc. And, we think it’s best to be safe, not sorry. A valuation professional can identify the most appropriate valuation method for your business. He can even serve as an expert witness in court to support the final value.
If you have any concerns about what could happen to your business in the event of a divorce, talk to your attorney.
4. Buy-out due to an owner’s death
When a business owner dies, the company or remaining owners may want to purchase his shares. And, they may be required to purchase them at fair market value, not at a price they set or negotiate. Typically, the company’s governance documents state that a qualified appraiser should determine the fair market value of those shares.
Questions may arise around business continuity. Who’s left to manage the business? An estate? Family members? Other owners? What happens to the value of the deceased owner’s interest? A business valuation may help you make informed decisions about the future of the business.
From a tax perspective, it’s not uncommon to need a valuation to settle the deceased owner’s estate and provide adequate disclosure to the IRS.
5. An owner leaves
If an owner wants to leave the business, she has ownership interest to divest. Inevitably, people will begin asking “Who gets what?” The process is the same as when an owner dies.
The company’s governance documents may require establishing fair market value for the buy-out of the ownership interest. Who should determine fair market value? A qualified appraiser. Plus, the governance documents may require the owners to use a qualified appraiser for this job to ensure objectivity and accuracy.
Even if a valuation isn’t required by the company, it’s a good idea to have it done so the owners know that transactions are reasonable and transparent.
6. Adding owners
If you’re thinking about adding a new owner to the ownership team, a current business valuation will help you establish a reasonable buy-in price. Plus, you may be able to provide the prospective new owner with critical information about the company’s financials and operations. The valuation can help inspire deeper discussions between the current ownership team and the prospective owner.
And, an independent valuation can help resolve any misunderstanding about the value of the company and provide greater transparency to the new owner. The new owner may feel more confident about the buy-in because the value is validated. It’s not a random, unsupported number that current owners say ‘feels right or fair.’
The valuation plays a critical role in establishing a common understanding between owners about the business.
7. Securing financing
Do you have plans to grow your business? Open a new location? Launch a new product? Expand your existing facilities? Upgrade equipment to take it to the next level? You may need a lender or investor to give you the funds to make it happen.
Presenting the lender or investor with an objective valuation will help them make their decision. Plus, the valuation can add credibility to your argument by showing how you compare to your competitors, highlighting areas for improvement, and more!
8. Growing your business
A business valuation exposes areas of growth, weakness, and risk. You can use these findings to create an effective growth strategy and set goals for your business. A valuation can be an excellent source of benchmarking for your company against its own past performance and competitors. It offers third-party insight into your business and may point out areas of risk and opportunity that you didn’t realize existed.
9. Insuring the business and its owners
If you obtain a valuation, you’ll know how much insurance you need to cover any life insurance buy-out agreements. Or, if a natural disaster hits or your business is damaged in any way, you’ll know how much you can claim. It’s a smart way to protect your business. Plus, it’ll help reduce workload and stress if an unfortunate event does occur.
10. Estate planning and other transfers
A valuation is necessary when transferring shares via gifts, making transfers to certain trusts, or using stock-based compensation. To plan for these transfers, you’ll need a recent business valuation. In addition, there are significant reporting requirements that require valuations.
A business valuation is a powerful asset when you’re experiencing any type of business disruption – good or bad. It can help you make the right choices that align with your goals and needs. But, don’t think you have to wait for a problem to arise to hire a valuation professional! Be strategic and consistent. Use a valuation as a measurement tool. Consider having a valuation done with some regularity. See how the value of the business changes, find new areas of risk or improvement, and use the appraisal as a compass for your business.
Originally published 9/27/2017. Updated 7/21/2021.
Are you wondering if you need a business valuation? Let’s talk!