Most small business owners know their company inside and out—that is, except for one important piece of information: how much their company would be worth if they put it up for sale.
The process of determining the value of a company is known as “business valuation.” It’s important for determining a good selling value, as well as for tax purposes and planning for the succession of a company.
To get an accurate business valuation for your company, you will need to work with a professional appraiser, who analyzes your company from an independent perspective. You can use the resulting valuation to help you or your beneficiaries pay less in taxes after the transfer or sale of your business, or to set a proper price before you list your company for sale.
The goal of any business valuation is to estimate the company’s Fair Market Value (FMV). FMV is the price at which the market dictates the property may change hands between a willing seller and buyer without either being compelled to buy or sell and both having a general knowledge of the relevant facts related to the business.
There are several common ways in which business appraisers evaluate the value of companies:
Discounted cash flow: This is the method most commonly used to value new businesses or companies that have much more volatile earnings than the norm. Appraisers attempt to forecast earnings for the next few years. They then apply a discount rate to each year of these forecasted earnings to help them account for the time value of money.
Earnings capitalization: This calculation involves the appraiser looking at a company’s annual earnings over the previous year or several years. The appraiser then divides this figure by a certain cap rate, which is based on the risk associated with the company and the cost of capital. If, for example, a company earns approximately $400,000 per year and has a cap rate of 10 percent, the estimated FMV would be 400,000 divided by 10 percent (or $4 million).
Comparable sales: Appraisers may analyze recent sales of other similar companies in your market as part of their approach to determining the value of your business.
With all this in mind, it’s critically important for you to work with a qualified appraiser to get an accurate business valuation. After the appraisal is over, you will receive a full overview of the appraiser’s findings in a document you may then use to your advantage either in the sales process or when planning your business succession.
Keep in mind you will also have to pay for the appraisal, so you should take this into account in your planning. Ultimately, however, a reliable appraisal is an incredibly helpful tool if you are looking to sell your company in the near future. Meet with a skilled financial consultant to learn more about this process.