Business valuation: the highs and the lows

Curiosity aside, business appraisals are almost always triggered by a pressing need. Business people generally are interested in what the business is worth for these reasons:

• Business sale transaction, including sale of the entire company or offering a block of stock for sale.
• The need to raise additional debt or equity capital.
• Gift or estate taxes.
• Partner buy-in or buyout of a departing partner’s ownership interest.
• Litigation such as divorce or shareholder disputes.

In just about all of these situations business appraisal is a zero sum game: one side usually wants a higher result while the other is interested in lower business valuation.

Valuation of a business for sale

If you are a business buyer, you would naturally seek to lower the purchase price, hence the need for conservative valuation. On the other hand, if you plan to sell your business you would be most likely interested in getting the highest price possible for the company.

This adversarial relationship between parties to a business appraisal brings up an interesting question: is there a way to strike a balance between the conflicting interests of the parties involved?

Business fair market value is revealed in the market place

Since it is harder to argue against obvious facts, business people are likely to reach a sensible compromise provided there is sufficient evidence as to what the business assets are really worth. When in doubt, you can refer to the market place. If there are enough transactions involving similar businesses, the prices paid by others serve as a good starting point in your own negotiation.

Sale comparables and business value

The idea is that comparable business assets should sell for about the same price. In the consumer market this is very clearly the case. Consider the prices paid by a dealer for a used auto you offer as a trade-in for a new car. While your objectives and those of the dealer are directly opposed to each other, to make a deal you are likely going to agree on a price that fits somewhere in the range other car owners have accepted.

For a given car brand and condition, there are usually plenty of sales data to go by. So comparable selling prices tend to help you keep your negotiation relatively simple and straightforward.

The situation is similar with business assets. Those that can be easily substituted and sell often tend to have a pretty well defined price range in the market. But if your company owns some highly specialized assets, the situation could be more difficult.

Business valuation: beyond sale comps

The same applies to the business itself. If comparison is hard to make, arguments as to the business fair market value are likely. That is one reason a well considered, comprehensive business valuation is very important. You can demonstrate what the business is worth by using a number of methods, not just the market comparisons.

The more unique the business, the more such considerations as the earnings prospects, unique business value drivers and industry growth potential define its true value.

See Valuation Tour