A business valuation helps plan for unforeseen circumstances, details an exit strategy for the owners and lays out an execution plan for expansion; Business valuations use many different ways to come up with a value but what is always relevant is the business assets, liabilities, income, benefits and the current market in and outside of any particular industry sue.
Benefits of a Business Valuation
An unforeseen circumstance can devastate a company and a business valuation helps determine the price in the event a sale becomes an option. Someone who is interested in purchasing that business needs to know a value so that a sales price can be negotiated, and that value can be determined through a business valuation.
As a business grows and expands through the years, an owner could use a business valuation to keep employees motivated by offering stock options or additional compensation which would be directly related to the value of the business. A valuation also gives leverage to the business owner who wants to expand and obtains a valuation to present to a potential lender. The information from a business valuation can also be used to recruit key employees or used for employees who are looking at retirement. Another very important consideration is that a business valuation can be used for value in the event of a dissolution of marriage, or when one partner is buying out the other partner or when a business owner is going to have their child come into the business or just seeking investors and needs to know the worth of a business.
There are several methods to value a business and each methods considers more heavily one or more of the following factors: Value of equipment, inventory, property, liquid assets and any other property the company owns, as well as management structure, projected earnings, share price, and of course revenue. The best valuation method for you depends on why you need the valuation, the size of your business, and the specific industry.
Business Valuation Methods
There are three (3) main valuation methods:
1. Market Value Business Valuation Method
The Market Value Business Valuation Method is one of the most subjective in measuring the value of the business. This method compares your business to similar businesses that have sold. Very similar to a market analysis of real estate. This method will only work if you have access to the necessary data on similar businesses that have sold. Often small businesses do not have public records for comparison. This leads to a value that can be used for negotiation since you will have a subjective and speculative number, but it is a good starting point if you are looking to obtain an understanding of what your business might be worth.
2. Asset-Based Business Valuation Methods
The Asset-Based Business Valuation Method focuses on the total net asset value of the business less the total liabilities from the business balance sheet. This can be done on a business that is an “ongoing concern” which values of a business that will be continuing to operate. None of the assets are to be sold off and only looks at the business’s total equity which is assets less liabilities. This can also be done as a “liquidation” which is used when a business is at its’ end and the assets will be liquidated. The value is the net amount received once you sell the assets and pay the liabilities. Liquidation usually delivers a value that is lower than market value since usually there is some type of urgency involved.
3. ROI-Based Business Valuation Method
ROI-Based Business Valuation methods are used when you have someone who is most interested in the “rate of return”.
You could also use the following:
- Discounted Cash Flow Method or the income approach which is based on cash flow projections that are discounted to present value.
- Capitalization of Earnings Method which calculates the business’s future profitability based on cash flow, ROI, and expected value. This method works best for businesses that are stable since the calculation assumes that once the calculation is done it will remain stable for a long period.
- Book Value method calculates the value of the business’s equity (assets minus liabilities) as listed on the business’s balance sheet.
How do you choose which valuation method to use?
What works for one business may not work well for another based on the type of business as well as the reason for the valuation and what may have worked for a business valuation in a business five years ago, may not be appropriate today. You must keep in mind the actual business, the size of your business, if you are growing and how fast, profitability and of course the reason you need a valuation.
Valuation of “Personal Goodwill”
Another issue we face at times in the area of divorcing couples and business valuations is the issue of “personal goodwill” which, as you see from the descriptions of the business valuation methods, is not included in a business valuation of a closely held business. Our Illinois Supreme Court addressed personal goodwill in the case of In re the Marriage of Talty in 1995 when the court was first asked to distinguish between personal goodwill and enterprise goodwill. The Supreme Court set forth a method to use to determine how to calculate the enterprise goodwill in Illinois. “To the extent goodwill inheres in the business, existing independently of the owner’s personal efforts, and will outlast his involvement with the enterprise, it should be considered an asset of the business and the marriage. In contrast, to the extent that goodwill of the business is personal to the owner, depends on his efforts, and will cease when his involvement with the business ends, it should not be considered marital property”. These are mainly service businesses
Often times during a divorce we will see a business struggling and need to determine if it is real or is it a tactic in the divorce proceedings. A historical look at the business activity can often times tell a story of what is going on. A business valuator should be made aware of a divorce is part of the equation.
In a divorce situation, it is best to have a valuator brought in early in the case to help with the discovery process and make sure you ask for and receive the necessary information. Good reliable data is crucial for a good valuation. The business valuators I have worked with have lists of documents that are needed for valuation which are more than simple financial statements and tax returns. You can find a business valuation expert from the American Society of Appraisers (ASA), American Institute of Certified Public Accountants (AICPA), Institute of Business Appraisers (IBA), and National Association of Certified Valuation Analysts (NACVA).
If you’re facing a divorce and it is common to have concerns about dividing the various kinds of property and debts accumulated during the marriage. When you need assistance and advice from knowledgeable and experienced divorce attorneys, contact Anderson & Boback and we’ll be ready to help you with all aspects of your divorce including business valuation in divorce.