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What’s your business worth?

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Five things business owners need to know about valuation

As a business owner, you can have many reasons for wanting to know what your company is worth. You may want to sell your business or offer shares to employees. You could be interested in buying out a partner. You might need the value for tax or succession planning or an estate freeze.

Determining a company’s value is a complex process—part science, part art. Complicating matters is the fact that many entrepreneurs have an overly optimistic view of how much their business is worth.

Here are five things you need to know when determining the value of your company.

1. Differing expectations can cause conflict

It’s common for business owners to have a different value in mind than potential buyers, family successors, financial partners or tax assessors. This can lead to disputes, derail negotiations or affect post-transition plans.

Even if you’re giving the company to a family member, you may require a third-party valuation to ease conflict, plan your estate and optimize tax treatment.

Because of the complexity and stakes, it’s helpful to hire a chartered business valuator to get an objective and realistic understanding of your company’s valuation or determine whether a buyer’s offer is reasonable.

The process can also help you identify weaknesses in your company, find ways to boost its value and take steps to minimize your tax liability before a sale.

2. A variety of valuation approaches are available

Several valuation methods are commonly used. Valuations can also be done with varying levels of detail. Each comes with a different cost and level of assurance that the result accurately reflects your company’s worth.

The most suitable combination depends on the purpose of the valuation and the company’s characteristics, such as its profitability, future outlook and asset mix.

3. Valuation methods can yield different numbers

Three main methods are frequently used to determine the value of a company. A valuator may use one or more of the methods depending on available information and the type of business and transaction. Each method may yield a different value; the highest of these values usually reflects the fair market value of the business.

Earnings-based methods

These approaches are commonly used for established businesses that are generating reasonable returns and whose value is greater than that of their assets alone.

A valuator determines the company’s value by reviewing forecasted earnings or cash flow and past results. Different earnings-based approaches are used depending on whether earnings are expected to be stable in coming years.

Market-based methods

These approaches calculate a valuation by applying a valuation multiple, which may be based on EBITDA (earnings before interest, taxes, depreciation and amortization), revenue or other metrics. The specific figure used and type of ratio vary depending on many factors, such as industry and size of the company, market conditions and multiples used to buy or sell comparable businesses.

Asset-based methods

Asset-based approaches are typically used for businesses whose value is asset-related rather than operations-related—for example in the real estate sector. These approaches are also applied when a business generates poor returns or is expected to be liquidated.

4. Assets may be attractive

Your business may be more valuable in pieces than as a whole. For example, a buyer may want to buy your operations, but not your real estate holdings. A valuation exercise can identify ways to make your company more attractive to potential buyers—for instance, by putting real estate assets in a holding company that can be sold separately.

5. Valuation is just a guideline

Keep in mind that a valuator’s figure is just a guideline for how to approach negotiations in a sale. The final transaction price is often different and is influenced by many factors—for example, your eagerness to sell, the buyer’s strategic interests or expected synergies, available financing, due diligence and the company’s capacity to smoothly transition to new ownership.

For example, a company may be willing to pay a premium for your business because it’s a good fit.

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