By Wes Morgan
At first glance, this may sound like a difficult and infrequent question to answer. But it’s an important one if you’re considering taking on a partner, issuing stock or selling the enterprise. If you’re in the market to buy an existing small business, you want to know exactly what you’re paying for, and how that value was determined.
There may be other situations where establishing the value of a business is important. You may be considering spinning off part of your current business, or dealing with a dispute or litigation. Business value also figures in divorce proceedings and other cases where the value of one’s assets is a factor.
An accurate, up-to-date financial statement is only the first step in setting the value of a business. One must thoroughly analyze the past several years of business operations, and make an informed projection about the future — how that industry and economy will unfold, and how the company will compete.
Most people look to the fair market value of a business, defined by the Internal Revenue Service as “the price 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.”
But there are several ways to determine a fair and equitable price for the sale of the business. Among them:
- Capitalized earning approach. This is the return on the investment expected by an investor.
- Excess earning method. Similar to capitalized earning, except that return on assets is split from other earnings.
- Cash flow method. A method usually used when attempting to determine what proportion of a loan the cash flow of the business will support.
- Tangible assets (balance sheet) method. This method values the business by the tangible assets.
- Value of specific intangible assets method. This method is based upon the buyer’s desire to purchase an intangible asset versus creating it. It also considers the value of the business’s goodwill.
Unsure which one to use? That’s why professional assistance is especially valuable when dealing with business valuation issues. The National Association of Certified Valuation Analysts (www.nacva.com) offers a free directory to help you find a business valuation expert who specializes in your particular situation. You can also contact one of our specialist counselors at ashevillescore.org. to learn more about valuing your small business.
Wes Morgan is a SCORE volunteer mentor and a NAI Beverly-Hanks Commercial Broker. SCORE is a nonprofit organization whose volunteers provide free, confidential business mentoring and training workshops to small business owners.