Legacy Law Blog

A business valuation is key for understanding a privately held company’s monetary worth and for providing the owner with information necessary to make critical decisions.

Valuation aids in determining fair market values, evaluating the company’s financial health articulating potential risks. A business owner may obtain a valuation for various reasons including raising capital, seeking financing, strategic planning, going to market, succession planning and estate planning. 

A valuation offers the owner valuable insight into the company’s sustainability by measuring key performance indicators that will add or subtract to the bottom line. Oftentimes, an owner believes that because his company is profitable, it is also sellable. A valuation offers an objective perspective to the state of the company and every owner will benefit from the results provided. 

Valuation Professionals 

A business valuation is only as good as the person hired to provide the service and their understanding of the objectives behind the valuation itself. It starts with a credentialed professional or qualified valuation analyst. 

This person usually has a finance, business or accounting background which provides a foundation for understanding the purpose and operations of closely held companies. While one credential is not necessarily better than another, using a professional with credentialing significantly affects the quality of the valuation report and its ability to be a resource to the owner. 

There are various organizations that provide the credentialing for these professionals, and it is important to use someone who carries a recognized designation for the best information. CPAs often have the Accredited in Business Valuation (ABV) designation since it is offered through the American Institute of Certified Public Accountants.  

Other designations include Certified Valuation Analyst (CVA) from the National Association of Certified Valuators and Analysts; the Certified Business Appraiser (CBA) from The Institute of Business Appraisers; and finally, the Accredited Senior Appraiser (ASA) from the American Society of Appraisers.   

Purpose of the Valuation 

Once an accredited professional has been selected, holding a discussion about the purpose of the valuation is critical. Different valuation formulas and lenses are used to compile the data found in the valuation report.   

Is the owner embroiled in shareholder litigation? Is the owner getting a divorce? Contemplating selling the business to a strategic or financial buyer? Trying to pass wealth to the next generation? Engaged in strategic planning with the management team?   

Selling your business and transferring wealth will result in two very different valuation reports and values. Therefore, it is critical for the valuation analyst to understand the purpose of the report. 

Types of Valuation Reports 

The purpose of the valuation report is to determine the level of information provided.  

• A detailed report provides the most comprehensive information about the company. It is designed to stand on its own if reviewed by the IRS or a court of law.  

• A summary report is often used for financing, management planning, or a buy/sell agreement. By its name alone a summary report lacks certain information found in a detailed report, but it is more cost effective.   

• A calculation report is used in many situations where a valuation is not required, but a calculation in value, or certain financial analysis or advice for a decision is needed. 

Standards of Value 

As with the different types of valuation reports, there are different ways to calculate value, and each calculation supports specific objectives.

• A fair market value is used to determine the estimated price the business would sell for in a current, open market under normal conditions assuming both the buyer and seller have reasonable knowledge of the business’s value.  

• Investment value represents the worth of the business from an investor’s perspective and specific investment goals. It is more subjective and considers the potential for return on investment (ROI) and is influenced by cash flows, taxes, and risk tolerance.   

• Fair value is determined from the perspective of typical buyers and sellers in the market and involves comparing the business to similar businesses that have been recently sold and uses future cash flows discounted to their present value.  

• Finally, synergistic value refers to the additional value created when combining two or more entities (as in a merger or acquisition) that exceeds the sum of their individual values that accounts for the benefits like cost savings, revenue growth and strategic advantages realized by the combination. 

Key Value Drivers

Evaluating the key value drivers is critical for business owners to understand the potential risks to the company. By identifying the risks and then creating strategies to mitigate those risks, an owner immediately adds monetary value to the organization.   

Oftentimes, an owner will view these drivers with an optimistic lens and fail to see either the severity of the risk or sometimes, the risk itself. The valuation report offers an objective assessment of the key value drivers that are important in any industry as well as those that are industry specific.   

Key value drivers inside the company include the customer base, management team, employees, systems and processes and financials.   

Key value drivers outside of the company include competition, industry outlook, economic outlook and government regulatory climate. The key value drivers provide critical insight to the risks and sustainability of a company and will serve as a roadmap for strategic planning in any desired outcome. 

Valuation Approaches 

There are several ways in which a valuation analyst can approach the worth of the business, and again, it will depend on the purpose of the valuation. These include the asset-based and income-based approaches to valuation. 

• In the asset-based or cost approach, everything on the balance sheet converts to fair market value. When using the market approach, the value is based on the market/sale date of similar companies.   

• The income approach analyzes the value based on the present worth of future economic benefits.  

• And the excess earnings approach is a hybrid of the asset and income approaches and serves its purpose most often in valuing intangibles.   

Not all approaches are equal, but each creates a helpful lens through which the owner can better understand the value of the company. 

Making Informed Decisions 

A valuation report provides a business owner with critical details necessary for her or him to make informed decisions about strategy, value, risk and opportunity. If you are an owner who is faced with making impactful decisions about your company’s future, its employees, vendors, customers, and how the organization’s value creates personal wealth to support your family, the value of a valuation is priceless.