As consumers, we are constantly tasked with assigning value to different products/services we encounter on a daily basis. Generally, we have a good sense of how valuable an item is and can make a purchasing decision without much effort. Think about going grocery shopping, we quickly assign value to the food on the shelves and make a decision to put the item in our cart, or not.
However, there are certain cases that are more challenging, and require the analysis and opinion of a third party expert in determining value. Valuing businesses is often one of the cases that requires more careful and robust analysis due to the complexity and magnitude of dollars at stake. It may be difficult even for those closest to the business, namely the owners, to determine the business’ proper price tag. There are a number of instances that would necessitate a business valuation, which I have detailed below.
Why do you need a business valuation?
- You are trying to buy/sell a business or business interest
The purchase or sale of a business is often the first thing that comes to mind when the topic of business valuation is brought up and for good reason. As a buyer in any transaction, you want to make sure that you are not overpaying for what you are receiving. Absent a business valuation, can you be comfortable as a buyer that you are getting a fair price?
On the sell side, you want to make sure you are getting a reasonable price for your business. As many Baby Boomers are retiring and looking to sell their businesses in the coming years, they may have a significant amount of their personal wealth tied up in their business. They may be relying on the sale proceeds from their business to fund what is hopefully a lengthy and comfortable retirement. If a business valuation is not done, how can you be sure money isn’t being left on the table?
- You are making a change to the existing ownership of your business
Ownership changes can happen fairly frequently for privately held businesses as new partners are admitted, as existing partners exit, or as ownership is re-shuffled within the existing partner group. Instead of selling the entire business, a retiring partner may transition the ownership of a business to other family members or key management employees. If you are a new partner that is gaining an ownership share in the business, how are you able to know the true value of the ownership shares that you are buying without a business valuation? If you are exiting the partnership, a business valuation may help you determine if you are being fairly compensated for what you are giving up.
- You want access to new sources of capital
It can be very important to have a valuation in hand when trying to obtain new equity dollars from investors. This idea is on full display weekly on the show “Shark Tank.” The entrepreneurs have a valuation that they pitch to the “Sharks” as potential investors. The same applies to any business owner looking for additional equity partners. If the owner has not had a formal business valuation, the pitch may not prove to be enticing to any potential investors.
A valuation can also be helpful in attempting to obtain bank financing. Banks want to be secure when lending and a valuation can provide the support needed to access debt financing.
- You want to grow the value of your business
There are some instances where quarterly/annual reports to partners/shareholders require a business valuation. Investors are generally interested in maintaining up to date reports of the value of their investment. Obtaining business valuations over a period of time can help the owners and management of a company measure the progress they have made. This can be an important benchmarking tool as owners/management can determine the strategies and tactics that contribute to growing the value of the business. A valuation can provide insights into the specific actions that management can take to grow the business in preparation for a sale, ownership change, pursuit of new capital, and countless other situations.
As all of these examples show, obtaining a business valuation is beneficial in a variety of circumstances and for a variety of planning applications. Although business owners may have a vague idea of what their business is worth, it is usually a guess. More often than not, relying on a guess proves costly. Obtaining a business valuation, to understand the true value of your business, is invaluable information for business owners to have.