Selling your business may be the most important financial decision you ever make.
A business purchase is also a big event for the buyer, and both parties want to negotiate a fair price. A valuation is a major component of the price ultimately received for your business.
Owners should insist on a certified business valuation, rather than a ballpark estimate of value. Both the buyer and seller may have more confidence in a valuation prepaid by a third-party expert.
The Value of a Certified Business Valuation
A certified business valuation provides several benefits, particularly for privately held firms.
A private company’s equity does not trade on a public exchange, so the market value is difficult to determine. A certified valuation provides stakeholders a reliable estimate of value.
Both buyers and sellers are more likely to accept a certified valuation, because the analyst must follow accepted industry guidelines. As a result, the conclusions reached in the valuation may be accepted by both parties.
The valuation can serve as a starting point for the sale price negotiation. Both parties will have reasons that justify their proposed sale price. A certified valuation can help buyers and sellers reach an agreement in less time.
A court is more likely to accept a valuation from a certified expert. If business partners want to dissolve a partnership, for example, the owners may disagree over the value of the firm. If the case goes to court, a judge may rely on a certified valuation to determine the company’s value.
Estate taxes and gift taxes
Several tax situations require a business valuation. If an owner or partner passes away, the value of the firm may be included in the owner’s gross estate. The tax preparer needs a business value to file the estate tax return.
When an owner gifts shares of company stock, the transaction may generate a gift tax liability. To calculate the owner’s gift tax, the CPA needs a value for the stock. A private company’s valuation helps to determine the value per share of stock.
If a tax return is audited, a valuation prepared using certified valuation standards is more defensible.
There are several organizations that offer a valuation credential.
Types of Credentials
- Accredited in Business Valuation (ABV): The AICPA grants this credential to CPAs and qualified valuation professionals.
- The National Association of Certified Valuators and Analysts (NACVA): NACVA supports users of business valuation and financial litigation services by issuing the Certified Valuation Analyst (CVA) designation.
- American Society of Appraisers (ASA): This organization confers several credentials, including Accredited Senior Appraisal.
Valuation experts use a number of approaches to value a business.
Here are three frequently used valuation methods.
To understand this approach, consider the balance sheet formula:
Assets less liabilities = equity
- Assets: Resources you use to produce revenue, including machinery, equipment, and vehicles.
- Liabilities: Amounts owed to other parties, including accounts payable and long-term debt.
- Equity (book value): The difference between assets and liabilities. If you were to sell all of your assets for cash, and pay off all liabilities in cash, the amount remaining would be your firm’s equity.
An analyst may use the fair value of assets and liabilities to calculate business value. It’s important to include only those assets owned by the company, and not assets personally owned by the founder.
This approach calculates the value of the business based on a firm’s ability to generate cash inflows.
Using this approach, the analyst will consider the expected cash flows that a business can generate in future years. Assume that a clothing retailer is expected to generate $100,000 in cash flows over the next three years. The cash flows can be discounted to present value, using a specific discount (interest) rate.
The valuation may use other metrics, including earnings per share, to assess the value of the business.
A valuation should also consider recent sales of companies in the same industry.
This approach considers the value of similar businesses that have been sold recently. If the seller owned a furniture manufacturer, the analyst would consider the recent sales of other manufacturers in the same industry.
If, for example, buyers have recently paid three times company revenue for furniture manufacturers, that data would impact the business valuation.
Keep in mind that a buyer may purchase the entire business, or buy specific company assets.
Equity vs. asset purchases
The valuation will be impacted by the type of purchase the two parties negotiate.
In an equity purchase, the entire balance sheet (assets and liabilities) is sold to the buyer. The valuation would analyze the assets owned and income generated by the business as a whole.
If the parties agree to an asset purchase, the valuation will assess the specific assets sold, and the income that the assets can generate.
Say, for example, that a furniture manufacturer sells its customer list, office building, and warehouse. The seller chooses to keep certain machinery and equipment, and to use those assets in a different business. The valuation must take into account that the buyer will have to purchase machinery and equipment to operate.
A certified valuation can help both parties reach an agreement, but the components of a valuation are complex. You need an expert in your corner.
Rely on a Trusted Expert
Raincatcher has the experience and professional connections to ensure that your business is valued properly. The firm uses industry-leading proprietary valuation resources to value your business and support the proposed sale price.
Your Raincatcher business broker will be your trusted advisor throughout the sale process. A business sale involves a group of professionals, which may include a valuation expert, accountants, an attorney, and a business broker.
Work the Raincatcher, and sell your business with confidence.