The art and science of determining a business’s worth

For many business owners, approximately 40 to 60 percent of their net worth is their company. Given the impact a business transition will have on their future, the business owner needs to be aware of the business’s value to eliminate any unwanted surprises.

“To understand the value of a company, it’s important to have an experienced expert complete the process,” says Rob Zunich, a director at Barnes Wendling CPAs.

Smart Business spoke with Zunich about some of the aspects and processes involved in a business valuation.

What are some occasions when a business valuation is needed?
Business valuations can discover critical information in a number of situations. There are various circumstances that require a business valuation from a qualified expert. Some of these occasions include:

1)  Buy-Sell Agreements. Buy-sell agreements between co-owners stipulate what owners receive when a partner experiences a life-altering event such as death or disability. If co-owners specify an amount in the agreement that doesn’t adequately capture the true market value for the business, it can delay, complicate or potentially derail the transaction.

2)  Gifting or Estate Planning. Having a value for a specific ownership interest allows owners to effectively transfer wealth to other family members while also meeting IRS requirements.

3)  Succession Planning. A reasonably performed valuation can inform owners of what the marketplace value might be for their business. Occasionally, business owners experience a ‘value gap’ where their own assessment of what their business is worth and the market value are vastly different. A valuation performed well in advance of an exit can manage expectations or provide a roadmap for where action is needed to increase a business’s marketability to buyers.

How is the value of a business determined?
Performing a valuation is a mixture of art and science. There are certain standards or accepted methodologies, but the process also incorporates an amount of professional opinion and judgment. Every engagement provides its own unique set of circumstances.

Also, the type of value being determined is important to understand, and will dictate how certain underlying assumptions and estimates are factored. Appraisers will typically provide a detailed list of information they will want in analyzing the various financial, operating, quantitative and qualitative factors that will be used in their procedures.

Based upon the information provided, the appraiser will then determine which approach(es) are appropriate to consider. These approaches include:

1)  One method considers the underlying net value of a company’s assets deducting its liabilities (those recorded on and off the books). This approach may be utilized for companies that own underlying assets, such as investments or real estate, or for operating companies where the value of selling off the assets and paying off all liabilities provides a greater value than could be generated from the earnings.

2)  Another approach focuses on the earnings or cash flow as the potential benefit to a buyer, and also considers the risks associated with realizing those benefits. Professional judgment by the expert often comes into play in assessing an appropriate risk factor for those earnings.

3)  Lastly, an expert could look to a market approach, where data is assessed from public or private companies similar to the business being analyzed to derive pricing estimates based upon relevant factors.

What should be considered when looking for a valuation expert?
Cost shouldn’t be the only factor in choosing whom to hire. Rather, an owner should inquire about appraisers’ experience in performing valuations; their training, including continuing education; their background and knowledge of the respective industry; and their reputation within the professional community.

An owner should also consider whether such experts have valuation credentials or designations. These would be indicative of meeting certain minimum experience, knowledge and training requirements, and holding that expert to certain required professional standards.

Insights Accounting is brought to you by Barnes Wendling CPAs