How to Accurately Determine Your Business’ Value

The following article was provided by Whittlesey. It is reposted here with permission.

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For many owners of closely held businesses, the business itself is their most valuable asset. However, many business owners do not know the fair market value of that asset. 

Closely held businesses are privately owned, meaning value is not readily determinable like publicly traded stock. 

A business owner cannot simply look up the current stock price on a stock exchange, like an investor in, say, Apple or Amazon stock would be able to. 

A business valuation would need to be performed to determine the fair market value of the business at a specific point in time. 

(Note, fair market value is typically defined as the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts. For purposes of this article, the terms fair market value and value will be used interchangeably.)

What Is a Business Valuation?

A business valuation is an in-depth analysis of the business itself and the environment in which it operates. 

This includes an analysis of the economy (including global, national, regional, and local analysis, if applicable), the industry in which the business operates, a review of the business’s organizational structure and management team, a historical financial analysis of the business, and analysis of the future earnings capacity of the business. 

This analysis is then used to help determine a conclusion of the value of the business. 

A business valuation is a snapshot of the business at a point in time. 

A business valuation is a snapshot of the business at a point in time, and the value of the business can change based on changes in any of the above-mentioned factors over time. 

It should also be noted that the conclusion of value from a business valuation report may not necessarily be the value the business would sell for on the open market. 

Other factors may increase the value, including synergies with a specific buyer or investor, which would indicate a strategic value to a specific buyer, and not the fair market value.

Who Needs a Valuation?

While a business valuation is useful to any business owner, there are several instances where a business valuation report is required. 

The Internal Revenue Service requires business valuations for gift and estate tax filings to support the value of any transfer of ownership in a privately held business. 

Additionally, the IRS requires a business valuation to support a charitable contribution of privately held stock, or when a corporation converts from a C-Corporation to an S-Corporation. 

Further, the U.S. Department of Labor requires businesses to be valued if the business sponsors an Employee Stock Ownership Plan.

A valuation may be required for litigation purposes, including shareholder disputes and divorce.

Tax and regulatory requirements are not the only reasons to get a business valuation. 

A valuation may be required for litigation purposes, including shareholder disputes and divorce.

In addition to these requirements, oftentimes it can be very beneficial to a business owner to simply know the value of the business they own. 

This can be very useful for business succession planning (including buy-sell agreements) and estate planning. 

Even though a valuation is at a specific point in time, a business owner can learn very useful information from a valuation, including what factors are affecting the current value of the business and how to improve those factors and create increased value.

How Is a Business Valued?

While there are many methods used to value a business, there are three main approaches—an asset-based approach, an income-based approach, and a market-based approach. 

The asset-based approach looks at the net assets owned by the business to determine value. 

This approach is typically used for real estate or investment holding companies, or companies in liquidation. 

There are three main approaches to a business valuation. 

The income-based and market-based approaches are often used to determine the value of a going-concern, operating business. 

These approaches value the tangible and intangible assets of the business as one inseparable component. 

The income-based approach looks to the future earnings or cash flow of the business to determine a value. 

The market-based approach looks to recent transactions of sales of similar businesses or values derived from similar publicly traded companies to determine the value of the subject business.

Who Can Perform a Valuation?

When looking for a professional who can value your business, it is important to look for experience and proper certifications. 

There are several certifications and credentials available for business valuators, including the Certified Valuation Analyst issued by the National Association of Certified Valuators and Analysts, Accredited in Business Valuations issued by the American Institute of Certified Public Accountants, and the Accredited Senior Appraiser issued by the American Society of Appraisers.

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About the author: Gregg Lionetti is a senior manager in Whittlesey’s Hamden office. Lionetti has more than a decade of experience in public accounting. His practice focus is in closely-held companies, particularly in construction, manufacturing, distribution, and services industries, with experience in business valuations for closely-held businesses.