It is easy to criticize valuation clauses in most Buy-Sell Agreements as being inadequate.
Below are some of the valuation options from most rudimentary to sophisticated.
Valuation Type 1: Agreed-upon value
Method: The owners agree upon a value—often book value.
Reliability: Low, but for small businesses that are 100% reliant on owners for revenue, this valuation method might be adequate. There is very little, if any, value to the company apart from its asset value.
Valuation Type 2: Rule of thumb
Method: Owners (or perhaps an advisor) choose a valuation method common to the particular industry.
Reliability: Low. Most owners are familiar with at least one rule-of-thumb measurement of value for their industry. Too many owners of businesses with millions of dollars of annual revenue use them.
Valuation Type 3: Valuation from a credentialed business evaluator
Method: A credentialed business valuator provides a full valuation.
Reliability: Varies on the experience of the valuator and the level of the report. For example, a valuator who has completed 100 valuations in the past 5–10 years has much more experience upon which to base their opinion than does a valuator who performs one or two evaluations per year. Business valuation is an area in which experience and informed judgment matter.
Contact us today for a professional business valuation in Toronto and the GTA and understand the importance of your company’s financial assets.
What’s the Point?
In addition to matching the sophistication of the valuation type to the sophistication of the business (and the owner’s willingness to pay), advisors recommend the appropriate valuation type based on the purpose of the valuation.
If a client’s company is worth millions of dollars today, it is advised that the business owners obtain a valuation prepared by an independently credentialed business valuator when they execute the Buy-Sell Agreement.
Owners will likely rely on their advisors’ judgment about which type of valuation is appropriate for their business. Using a valuation prepared by an independent expert will generally be more reliable.