Addressing Common Business Valuation Questions

What is the business valuation process?  We address common questions and debunk misconceptions surrounding the business appraisal process.

Are Valuations Only for Selling or Buying a Business?

While business valuation is often associated with selling or buying a business, it is most often used for various purposes such as estate planning, divorce settlements, employee compensation, tax purposes, Employee Stock Ownership Plans, and strategic planning.

Are Valuations Completely Objective?

While there are objective methods for business valuation, subjectivity and judgment are important. Factors like market conditions, future projections, and risk assessments involve some level of judgment.  The key word is judgment.  The valuation is an opinion of value.  All the judgments made by the appraiser should be well documented in the report.

Is a Valuation Only Based on Financial Statements?

Financial statements are important, but they are far from the sole basis for business valuation. Appraisers will typically normalize an entity’s financial results to eliminate nonrecurring transactions and reflect market rates for owner driven expenses such as compensation to owners and family and rent paid to related parties.

Factors like a company’s earnings projections, changes in industry trends, shifting market conditions, and the company’s competitive position play a significant role.

Is the Opinion of Value a One-Time Event?

The short answer is yes.  The valuation date drives the business valuation, and the appraiser should consider what is known or knowable as of that date. Unknown or unknowable subsequent events should not come into play.  The value of a business will change over time due to market fluctuations, changes in management or operations, or shifts in the industry.

Does a Valuation Equal Market Price?

The value determined through a business appraisal is usually not the same as the market price.  The value determined depends on the reason the business appraisal is needed.  When an arm’s length transaction occurs between an entity and a financial buyer, the purchase price should be a strong proxy for the fair market value of the entity.  When an arm’s length transaction occurs between an entity and a synergistic buyer in the case of a merger, the purchase price may surpass fair market value and reach a higher value.  This reflects the synergies the buyer anticipates after closing the deal – cross selling opportunities, entry into new markets, cost savings are examples.  Market price is influenced by negotiation, buyer and seller motivations, and other external factors.

 Are Valuations Only Appropriate for Large Businesses?

Small businesses can benefit even more from a valuation. Large businesses that are publicly traded already know their value from the stock market.

Valuations are required for transactions that require reporting to regulatory authorities such as the IRS.  These include as with estate administration, gifts of ownership interests, compensation, employee stock ownership plans, among others.

Understanding the worth of your business helps in making informed decisions and in planning for the future.

Do I Need to Be an Expert to Understand Valuations?

Only the appraiser needs to be an expert. A well-written valuation report should provide a clear roadmap for the business owners to understand the conclusion. Collaborating with valuation experts may be needed.

Are Valuation Models Always Accurate Predictors of Value?

In any model, the quality of the output is determined by the quality of the input. Valuation models provide estimates based on assumptions regarding future financial earnings, expected nature of business operations, and information regarding a company’s market, industry, and the impact of the economy on the company. Assumptions should be reasonably sound and backed by data, otherwise the valuation model may not accurately predict value.

As we all know, circumstances can change quickly.  COVID-19 taught us all that fact.