Business valuation methods and models

You can value any business or professional practice three ways, known to professionals as valuation approaches:

1. Market – by comparing your business to similar businesses that sold recently.
2. Income – by assessing your company’s earning power and risk.
3. Asset – using the business assets as your valuation basis.

There are a number of well-known business valuation methods under each of these approaches. It is a very good idea to use several such methods to determine what your business is worth.

So what methods should you pick for your business valuation? The answer depends on your specific situation and the assumptions you make. Truly, business value is in the eyes of the beholder.

Valuation of a business for sale – buyer and seller’s numbers may differ

Consider a typical situation when a business is put up for sale. Business owners, naturally, would be very interested in the highest possible business valuation numbers. On the other hand, a business buyer is likely to be far more conservative when valuing a business to buy.

Conservative business valuations in gift and estate tax situations

Business owners looking to minimize gift or estate taxes will look for the lowest possible business appraisal. The same owners are likely interested in a higher number when presenting their business to strategic investors. Needless to say, the tax man will probably be skeptical if your business appraisal is too low.

Partner buyouts – two views of what a business is worth

In a partner buy-out situation the remaining partners want the lowest possible value for the departing partner’s share of the business. On the other hand, that departing partner is interested in a higher valuation. This is one reason why buy-sell agreements are important.

Are all these different business people fudging numbers? Not necessarily! What they are doing is factoring in their specific assumptions into their business valuation. And these assumptions affect the results they get.

Different assumptions affect your business valuation conclusion

The main point is that your business valuation numbers can differ from someone else’s. This does not disprove your business appraisal – as long as you can demonstrate that your assumptions and business valuation method choices make sound sense.

Business valuation model = key assumptions + choice of methods

Enter the business valuation model – the set of assumptions you make and business valuation method choices for your business appraisal. Based on your specific situation, your business valuation model may differ from mine – yet both can produce defensible business valuation results.

A business seller and buyer may come up with a different opinion of what the business is worth. To close a successful business sale though, they will likely arrive at a compromise – a number acceptable to both parties.

If you convince your investors that your business is worth a certain amount, then your business valuation works. You have made the right assumptions at the outset and picked the business valuation methods that made sense to your investors.

The moral of all this? Your business valuation is right if it serves its intended purpose.

To make sure that it does, you need to spell out your assumptions and be able to show clearly why your choices of business valuation methods are the best.

See Valuation Tour