At the 2012 Berkshire Hathaway annual meeting, Warren Buffett stated that the following was critical to all business owners: “If business schools could offer just one course, it would not be on stock trading, the efficient market hypothesis or modern portfolio theory. Rather, B-schools should be encouraging students to learn the boring, but critically important, discipline of business valuation."
Mr. Buffett continued to say that business owners should learn something about the process of valuing their business. Business valuation is a process best done by professionals, but it’s a product the business owner needs to understand.
The majority of business owners don’t know the true value of their company — whether it’s a C corporation, S corporation, partnership, limited liability company or sole proprietorship. Yet, the business is most likely their most valuable asset. Business valuation is a process to determine the economic value of a business or company. A detailed set of procedures are used to determine what a business is worth. While this sounds easy enough, getting a business valuation done right takes preparation, thought and expertise.
It’s always important for an owner to know the value of their business. For example, business owners should start thinking about their business succession plan as early as possible and certainly no later than at least five years before planning to implement it. But what’s the value that they’re planning for? Will it be enough if the goal is to sell the business to fund their retirement? Are they interested in selling the business to co-owners or key employees for a fair price? What is that price? Every business owner should obtain a business valuation before he or she even initiates the business succession process. Thereafter, in general, it’s a good idea to have a business valuation done regularly, at least every other year, because of changing economic environments and the success of the business as a going concern.
“If a business owner hears a valuation multiple, he or she may continue to refer to that number without consulting a professional, understanding how a business valuation works and ultimately knowing the true value of their business,” says Holly Taylor, CPA, ABV, ASA, senior manager at Rea & Associates.
It’s a common misperception to say that your company is worth four times EBITDA (earnings before interest, taxes, depreciation and amortization), as that doesn’t take into consideration your industry, business risks, cash flow expectation, debt and more, she says.
Why Business Owners Need a Business Valuation:
- Preparation in case something happens to the owner
If something should happen to the business owner, such as an illness or death, having a current business valuation will help the family deal with the possible sale or dissolution of the business. Business continuation or buy-sell agreements should have provisions detailing the price at which a business interest may be sold.
- Selling or Merging?
The opportunity to sell or merge might happen suddenly and a decision must be made quickly. Having an up-to-date business valuation enables you to take advantage of the right opportunity at the right time.
- Considering an exit strategy
Retirement comes quicker than most people realize and they need to know the value of their business to form an exit strategy. This could mean a restructuring of the business, not necessarily a sale or a closing of the business. Knowing exactly how much the business is worth will help the owner to strategize timing as well as numbers.
- Business expansion
Perhaps it’s time to build additional facilities or to expand the practice. Having a business valuation in hand along with a business plan to show the bank will help them determine loan approval.
- Adding on a partner
Is it time to add on a new owner, partner, or LLC member? A business valuation will be needed to pinpoint the buy-in price.
- Departure of shareholder or partner
Separation from co-owners, co-shareholders or partners for one reason or another is fairly common and numbers will help to either buy out the co-owner or to divide the business up.
- Divorce or creditors
Undergoing a divorce or dealing with creditors will require the business owner to know the value of the business since the business may be the focus of the discussion.
Business value is really an expected price the business would sell for. You may have heard the term “fair market value.” Fair market value is defined as “The amount at which the property would change hands between a willing buyer and willing seller, when the former is not under any compulsion to buy, and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.” IRS Revenue Ruling 59-60. Professional valuation appraisers can help you determine what that value is. Before you go into the valuation process, you should have an idea about what you are going to do with the results and the purpose for the valuation.
To get an accurate value, use an experienced, credentialed professional who will take all the factors and variables into account. CPAs who have earned ABV (Accredited in Business Valuation) designations might be a good place to start. Professionals with Accredited Senior Appraiser (ASA) designations granted by the American Society of Appraisers is another one. Professionals with Certified Valuation Analyst (CVA) and Accredited Valuation Analyst (AVA) designations granted by the National Association of Certified Valuation Analysts are other valuation experts you can rely upon. Talk to your financial advisor or planner who may have relationships with these valuation experts.