Business valuation: facts and fiction

Getting a business appraisal that is accurate and defensible can make a difference of thousands and even millions of dollars. Whether you are planning on a business sale or purchase, handling a legal dispute or tax matter, a key part of your strategy should be knowing what the business is worth.

Since the stakes are high, it is important to separate facts from fiction when it comes to valuing a business. Here is our short list:

Fiction: There is only one way to value a business.

Fact: There are three ways to value any business.

Indeed, you can determine the value of your business using these three approaches:

1. By comparison to recent sales of similar businesses.
2. Based on the business’ earning power and risk assessment.
3. Based on the company’s assets.

In addition, you have quite a number of business valuation methods to choose from under each approach. Consider using several methods if you intend for your business appraisal to be taken seriously.

Fiction: Business valuation is just a number.

Fact: Business valuation results depend on your assumptions.

It may come as a surprise to some: the business value number you get depends heavily on the set of circumstances that led to the business appraisal. If the plan is to close the business down and sell off its assets at an auction, the business value result is likely to be low.

On the other hand, a business appraisal done in expectation of a strategic business investment and rapid growth in business earnings is almost certainly going to result in a much higher number.

Fiction: Business valuation takes a couple of minutes to do.

Fact: Business valuation takes time and effort.

While the number crunching using business valuation tools can indeed be quick, the accuracy and relevance of your business appraisal depends critically on how thorough you are in your analysis.

Business appraisal is always forward looking. This means that you need to consider the business earnings prospects over the next few years. You also need to figure out what types of risks the business is likely to face. Don’t expect to get this done over a coffee break!

Fiction: Business value is the same no matter who measures it.

Fact: Business valuation results depend on who appraises the company and why.

This goes back to the assumptions point. Since business value is about a game plan that leads to future earnings, your vision of what a business can do may differ from someone else’s. The result is two different business valuation conclusions. Neither is wrong – but both depend on who was doing the appraising!

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