Business valuation is a vital component to an effective planning strategy. It allows entrepreneurs to understand what drives the value of their company and implement key changes in their business model to prepare for the future.
Without a reliable third party valuation, the business owner may arrive at an unrealistic sense of how much the company is worth which will likely be at odds with what potential investors, other shareholders and other important stakeholders come up with.
In this article, we cover the importance of an unbiased business valuation report. We also touch upon how timely business planning and valuation services in Toronto can help you avoid serious consequences!
How is business value determined?
As set out below, there are three main approaches a business valuator can use to determine a company’s value:
Asset-Based Approach
The asset based approach, sometimes referred to as the cost-based approach, utilizes the company’s balance sheet to establish value. Assets and liabilities are adjusted from their book values to their market values to determine the net asset value or equity value of the business.
Income-Based Approach
The income based approach determines business value based upon a company’s capacity to generate future income and/or operating cash flow. An estimate of the company’s future annual net income is determined and then discounted to a present value using an appropriate discount rate (or valuation multiplier), which is selected based on an assessment of the various risk factors that could impact those future annual operating profits. Different variations of the income based valuation approach include the discounted cash flow method, capitalized cash flow method, capitalized cash flow method or excess earnings method.
Market Value Approach
The market approach estimates value by comparing the subject company to actual transactions in the industry or to actual trading multiples of public companies in the industry. This approach is not generally utilized as a primary valuation approach given the shortcoming associated with being able to find transaction targets or public companies which are truly comparable to the subject company. As a result, they are often used as a secondary approach or as a reasonable test on the value conclusions arrived at under an income approach.
An independent and unbiased valuation professional can help you unlock the true value of your business not necessarily reflected in the company’s year end financial statements. An independent business valuation provides a reliable valuation range upon which to enhance value, implement tax and exit planning strategies, base your buy-sell agreement, avoid future disputes/litigation and manage your overall value expectations.
Why do I need a valuation?
There are many reasons to have your business valued by an independent valuation professional:
- To establish a figure upon which buy-sell agreements are based on (even more so if you’ve never conducted a valuation before)
- To understand how to develop strategies, improve profitability and maximize business value prior to an exit
- To assist in pre-sale business planning
- To determine the annual per-share value of an ESOP(Employee Stock Ownership Plan)
- To assess the value of a portfolio of intangible assets (e.g. patents, copyrights, trademarks, intellectual property, etc.)
- To root out business weaknesses and recalibrate operations to improve the bottom line
- To obtain financing from a bank, venture capitalist, or other lending institution
- To allocate a purchase price to various intangible assets acquired and verify if there is impairment in goodwill
- To set value expectations and avoid marital, shareholder or partnership disputes
- To aid in estate tax reporting purposes for a decedent
- To properly plan gift taxes whether that includes transferring an interest to a family member, donating to a charity, transferring to a trust, etc.
- To assess whether the business is growing, stagnant or declining in value over time and whether restructuring is the need of the hour
How long is a business valuation good for?
When properly performed, a valuation that takes into consideration a business’ intrinsic value such as assets and earnings can be valid for as long as the underlying assumptions are valid (assuming no significant changes to external, uncontrollable factors such as industry and competition).
It would be tricky to establish a time frame as some assumptions, whether these are economic trends, competition, management, world events, etc., fluctuate rapidly whereas others do so slowly.
Know that a majority of valuations are open-ended as their underlying purpose is intended to be long-term. So for instance, litigation appraisals, merger and acquisition reviews and estate tax returns are usually one-time tasks.
Generally speaking, it may be reasonable to assume that 80% of valuations hold for at least a year.
Can two separate valuators arrive at different results?
A valuation is performed anticipating what a hypothetical buyer would pay for the business.
It is possible for two separate valuators to arrive at different value conclusions. The valuation outcome depends on the expertise of the valuator and their familiarity with the industry, the underlying assumptions, differences in judgment, etc. All these factors impact the valuation conclusion.
An inexperienced valuator could unknowingly commit certain errors or omit integral information in the report, giving way to further discrepancies.
This is why it’s always advisable to approach a trusted and experienced business valuation professional.
How much does a business valuation cost?
The cost of a business valuation report can vary based on the size and complexity of the business, the purpose of the valuation and the type of valuation report required. A ballpark estimate for a small to mid market, privately held, operating company would be in the range of $5,000 to $15,000 (or more for more complex companies or contentious issues in the context of a legal dispute).
At VSP, our credentialed and experienced team strives to provide reliable, supportable and affordable valuation services so that you won’t have to spend a fortune to secure your future.
Get Your Valuation Done Ahead of Time to Unlock Some Serious Benefits
You may not be in the midst of a buy-sell agreement at this very minute, nor do you see yourself selling your business any time soon. Don’t take a gamble. An unforeseen dispute or unexpected offer could crop up when you least expect it!
Contact VSP to learn how we can help you protect and secure your company’s future.