Business valuation helps determine the value of a business or other intangible assets based on its performance analysis, the performance of similar businesses, and an estimation of future cash flows. It gives you an independent look at the value of your business, allowing you to understand better what needs to be done to achieve growth, profitability, and shareholder value. And this is done by a certified business valuation expert. In this blog, we will discuss the top 10 reasons for business valuation you can consider. These will help you understand the importance of business valuation and that of hiring a business valuation expert.

Business Valuation Is Not An Option — it’s a requirement if you want to succeed as a business owner. There are several reasons why you should consider having your business valued. Before jumping onto it, let’s jump into the basics of business valuation.

You might also want to read: The Ultimate Business Valuation Guide for 2023

Business valuation: A brief introduction

Business valuation is the process of determining the value of a business, for example, in order to determine the amount of capital required to purchase it. The valuation may be done on a fair market basis or by other means, depending on the circumstances.

Parties involved

The company valuation process is used by various parties, including:

• Business owners who are considering selling their businesses and want to know the fair value of their companies
• Investors who want to purchase a business from its owner or another party
• Lenders who may be providing funds for an acquisition or expansion and need to determine how much risk they are taking on
• Insurance companies who may be paying out claims after a disaster strikes a business.

The business valuation process

The company valuation process begins with identifying the business to be valued. The most common ways to do this are:

• Identify the company’s assets and liabilities
• Identify the company’s earnings and cash flows for a set period (typically one year)
• Value each asset using an appropriate method, such as discounted cash flow analysis or relative valuation.

Once the business has been identified and its value estimated, it is necessary to compare this value with that of similar businesses. This comparison is performed by analyzing metrics such as return on investment (ROI), the price-to-earnings ratio (P/E), and dividend yield.

The most important thing to consider when comparing multiple businesses is that they are comparable in all important respects. If all the companies in question are publicly traded, it makes sense to compare their P/E ratio. However, when comparing private companies with public ones, it is important to consider the fact that their earnings may not be comparable.

Note: If you want to know more about the different business valuation methods which are used to carry out the company valuation process, you may check out our detailed blogs on each method below:

1. Everything You Need To Know About Business Valuation Asset-based Approach
2. A Complete Guide To Understand Business Valuation Market Value Approach

Factors to consider when valuing a business

When valuing a business, it is important to consider the following factors:

• Business characteristics. The industry, size and scale of operations, growth potential (including barriers to entry), and competitive landscape are all critical when comparing businesses. In some cases, such as with technology companies, these factors will be more important than others.
• Financial characteristics. The financial performance of the business is an important factor in valuation. Companies with strong cash flow and earnings are generally more valuable than those that do not have these attributes.
• Risks associated with the business. The risk of taking on the company as an investment must also be considered. If the business has a strong competitive position and is well-managed, it may be less risky than one that does not.
• The availability of management talent. A company’s management team can make or break its value as an investment opportunity. If the company has a proven track record of success and has assembled a capable management team, this will likely add value to the business.
• Industry trends. Industry trends can impact the value of a business, especially if it is important to the economy’s future. For example, if there is an increase in demand for a product or service that your company provides, its value may also increase.

Top 10 reasons for business valuation

Now that we are through with the basics let us understand the importance of business valuation, why is it necessary.

Succession planning

Business valuation is essential to succession planning because it enables management to determine the value of its business. This process can be used to determine the fair market value of your organization so that it can be sold to a third party, or new owners can purchase it at a fair price.

Business valuation is one of the most important processes in succession planning because it helps you:

• Determine what you are worth by determining the value of your company
• Assess if there is any value in your company that can be sold or passed on to heirs
• Ensure that whatever value exists within the company is properly recorded, valued, and accounted for
• Ensure that any future transactions involving the organization are carried out in accordance with GAAP (Generally Accepted Accounting Principles)

Exit Strategy

Business valuation is important for exit strategy planning because it helps companies determine their strategic direction and their market value. This is especially important in times of uncertainty, such as a recession or a period of rapid change. The business valuation process is also used to determine the amount of capital a company needs to raise to finance its expansion plans, evaluate its real estate holdings, or acquire other companies.

Business valuation aims to determine an accurate market value for a company’s shares, bonds, or other assets. This can be used as the basis for negotiations with investors or lenders who may provide funding for investment activities or acquisitions. Business valuation also offers advice on how much money should be contributed by each investor to ensure that they are all receiving fair returns on their investments.

Estate & Gift Tax

Estate and gift taxes are levied on the transfer of real and personal property by a decedent. Under federal law, the federal estate tax is imposed on an individual’s gross estate value when they die. The federal gift tax is imposed on cash transfers and other assets made to family members during a lifetime.

Business valuation information can be used in conjunction with data, such as your income tax return, to determine whether you owe any gift or estate taxes.

Mergers & acquisitions

Business valuation is important for mergers and acquisitions because it allows the acquirer to determine the value of the acquired business. To determine this value, an acquirer needs to understand how much it will cost to purchase the assets and liabilities of the target company.

Acquirers also want to know if they are paying too much for the assets or liabilities of a given target company. Business valuations can help provide answers to these questions.

Buy/sell agreements

For a company to create a buy-sell agreement, it may first require an evaluation of its worth. Contracts like these are useful for both tax and business reasons. A valuation may be required to establish a fair value for estate and gift tax reasons if a sale involves related parties.

When one owner of a closely held business wishes to retire, leave the business, or passes away, the remaining owners can buy out the retiring, leaving, or deceased owner’s shares under the terms of a buy/sell agreement. These contracts typically include a set price or formula to facilitate the sale of an existing owner’s interest to the remaining owners.

Keeping up with the evolution of the company’s performance over time necessitates that a valuation analyst revisits this pricing or formula on occasion.

Shareholder & partnership buyouts/disputes

A buy-sell agreement is useful for minimizing the potential for conflict in a partnership or limited liability company. When negotiating terms that will satisfy all parties involved, it helps to have a price in mind that everyone can agree on.

Shareholder buyouts are common in closely held enterprises due to retirement, the addition of a new partner, the death or divorce of an existing shareholder, or a conflict between shareholders. If one party feels they got too little or paid too much in a buyout, it can be quite expensive.

Even in the presence of a buy-sell agreement, the shareholder(s) may find it beneficial to retain the services of an expert in business valuation.

By conducting a thorough and defensible valuation analysis and writing up a report that details the elements affecting the worth of the firm and the conclusion of value, a business valuation can assist reduce the risks involved with a shareholder buyout.

Allocation of purchase price

A business valuation helps in the allocation of the purchase price. The purchase price is the maximum amount that can be charged to the customer for a good or service.

The purchase price includes all direct costs to the company, including wages, overheads, and profits. To calculate the purchase price, you need to know the value of your business at the time of sale. This value is commonly referred to as the goodwill or book value, representing what you would be paid if you sold up immediately.

You can use this value as a starting point for calculating your profit margin and then determine how much profit you can expect before tax is deducted.

Marital dissolution (divorce)

Business valuation can help solve marital dissolution (divorce) because it lets both parties know their rights and obligations in a divorce settlement.

A business valuation report also includes information about what each party owns and owes, which will be used to calculate child support or alimony payments if necessary.

The business valuation report will also show how much each party is entitled to in a divorce settlement. This can help protect your rights as an owner of the business and prevent either party from taking advantage of the situation by attempting to hide assets or misrepresenting financial information.

Insurance purposes

In the event of the owner’s untimely demise, the value of their stake in a closely-held company may need to be insured. Therefore they may seek a valuation. Such a value is bought as key purchase insurance.

In the event of the owner’s untimely demise, the insurance payout might give the owner’s heirs the financial means to either carry on in the owner’s role or buy themselves out of it. A key person’s insurance coverage and any accompanying buy-sell agreements may alter these guidelines.

Financing/SBA loan

If you’re looking to obtain financing for your business, one of the first things you’ll need is a business valuation. This will give potential lenders an idea of how much your business is worth and help them determine whether or not it’s worth lending money to.

There are a few different ways to finance a business, but one of the most popular is through an SBA loan. The Small Business Administration (SBA) is a government agency that offers financial assistance to small businesses. One of the ways they do this is by guaranteeing loans made by private lenders to small businesses. This means that if you default on your loan, the SBA will pay back the lender.

It is common practice for banks and the SBA to request a business valuation before approving a loan, especially for large purchases like buying a company or a business interest. To better understand a company’s financial health, it’s important to understand the context in which financial statements are provided. An appraisal will give the bank an idea of how much of the property’s fair market value can be used to support a loan.

ESOP

A business valuation helps in ESOP by providing a fair market value for the company’s stock. This valuation can be used to help set the price of the stock and to help determine how many shares should be allocated to each employee.

An ESOP, or employee stock ownership plan, is a way for employees to own a stake in their company. This can be a great way to incentivize and retain employees, as they will have a vested interest in the company’s success.

A business valuation can help ensure that the ESOP is fair to both the company and its employees. By providing a fair market value for the company’s stock, the valuation can help set the stock price and determine how many shares should be allocated to each employee. This can help avoid potential issues down the road and ensure everyone is on the same page from the start.

Conclusion

Business valuation is important because it helps determine the value of a business and its assets. This information is crucial for various purposes, such as selling a business, attracting investors, obtaining financing, and making informed business decisions. Business valuation importance also plays a key role in divorce proceedings, estate planning, and intellectual property disputes. In short, business valuation is a crucial aspect of any business and its success.

With Arrowfish Consulting, your search for a true business valuation expert ends here. We have a staff of business appraisers with a combined 100+ years of experience, making us a go-to resource for anyone needing professional valuation services.

Our “qualified appraisers” are well-versed in the IRS’s guidelines for conducting gift and estate valuations. In addition, we have on-staff certified valuation analysts (CVAs), certified public accountants (CPAs), certified financial analysts (CFAs), and economists. Get in touch with our customer service team and schedule a free no-obligation consultation with our professionals to discuss your needs and how we are a good fit as a solution.

Jeremiah Grant

Jeremiah Grant is the Managing Partner of Arrowfish Consulting. In addition to acting as a primary liaison for many of the firm’s engagements, He primarily focuses on business valuation and economic damages expert witness assignments, in addition to forensic accounting and insurance claims analysis.

•