Business Valuation Blog | Understanding Buying / Selling a Company

The definition of a small business will vary depending on who you ask or where you research the term. Based on the number of employees, owners, investors, annual revenue, profit margins, and specific marketplace a company competes in, your operation may likely fall into this category. The fact is that the majority of companies today are considered small businesses, especially when compared to the conglomerates who have taken over large market shares in recent years.

The Small Business Administration (SBA) has a broad definition, which varies greatly based on the overall industry and company structure. This has benefited many who have worked with the SBA on start-up or refinancing opportunities, as well as the related services this organization provides to business owners. Regardless of the definition, if you're considering getting a company valuation as a small business owner, you're making a prudent decision to independently assess where you are today and preparing for the future.

One of the primary reasons small businesses need an appraisal is when considering a sale or change in ownership, such as a transfer to the next generation in the family. In this example, the departing owner wants to realize a fair value independently of any subjective opinion within the family. The relative taking over the business wants to be comfortable that they're not paying too much during the transfer. The formal valuation process creates an effective tool to help both sides realize a favorable outcome.

The appraisal process begins with a review of a company's finances while completing a questionnaire that provides the valuation professional with the data needed to consider the history and future plans of the company. The next steps involve reviewing the industry to determine how your company fits into the broader marketplace. Is it currently growing or stagnating? It's important to know how your company has been doing historically in the market, but also critical to look toward future long-term viability.

A small business appraisal is a valuable tool that can be used to improve your company's operation while gaining a realistic understanding of its current value. Ensure that you engage with a certified business valuation professional with at least 5-10 years of independent experience, so you can capitalize on their insights.

When you're deciding how to value your company, there are so many considerations to take into account to ensure your business valuation gives you the most accurate picture of your business' overall health. Should you use income-based appraisal? Or does a gross revenue multiple method make more sense? What purpose will your business valuations serve? Let's take a look at considerations when you're looking at valuation of a company.

How to value a company

Firstly, what's involved when you're figuring out how to value your company? Business appraisal is a complicated topic, one that many professionals spend their entire life learning about and applying to best suit their client's needs. The first step is to determine what your purpose is for business appraisals. Are you getting ready to sell or merge your company? Are you closing your doors for an asset liquidation? Perhaps you need to know where your company stands in the market compared to similar businesses and it won't work with the standard models. Any of these are common reasons for having a business valuation completed.

Why? Because knowing exactly what your company is worth helps you determine how to make business decisions for the future.

Which approach you should use

There are essentially three major valuation approaches to how to value your company. Let's take a look at each one, which methods are used and for which applications they work best.

• Asset-Based Approach: Book Value provides a fast answer, but it's not really accurate to your company's big picture since it is more of an "accounting number".  Adjusting to fair market value of the assets is a good approach.
• Income Approach: An income approach looks at what the business is projected to make in the future. There are two basic income approaches, Capitalization of Earnings used for steady, regular income and Discounted Earnings, also referred to as Discounted Cash Flow, which works with irregular income streams.
• Market Approach: The market approach observes what the market will bear and makes an assessment based on the sale price of similar companies which is then adjusted to account for the differences between the companies. These methods amy include Guideline Public Company, Guideline Company Transactions, or Multiple of Discretionary Earnings and Gross Revenue Multiple.

Why it's important to have a valuation specialist do the job

Though some business owners try to provide their own business valuation, they often find out later that the appraisal is not considered acceptable for financing, insurance or legal purposes. A valuation specialist only provides business appraisals, so they know the best approach and methodology to meet your business' needs.