Most business owners will have a valuation conducted a handful of times throughout their career. For this reason, there is often a great deal of uncertainty around business valuations, their purpose, and value they can bring. It is important to note that there are very specific circumstances under which a business owner needs to have a business valuation conducted. The most common is when a business is being put on the market for sale and a fair and accurate value of the business needs to be established. There are other reasons valuations need to be conducted including establishing partnership agreements, buy-sell agreements, exit planning, and litigation. For this reason, most have questions about the process, required information, valuation methods, and how long the report is valid for. To help clients, prospects, and others understand valuations, Sikich has provided a summary overview below:
When are Valuations Needed?
As mentioned above, most business owners seek a valuation when they are preparing to sell the company, are engaged in succession planning, or for other transactional purposes. However, there are other situations where a valuation may be needed including for litigation, tax reporting, and planning purposes. Because the business is the most valuable asset owners possess, it is common to need a valuation for tax reporting purposes including estate and gift tax planning, charitable donations, and corporate entity conversion. Although unpleasant, the value of the company is required in litigation actions such as marital dissolution, shareholder disputes, economic damages, and fraud. Finally, a business valuation is used by many business owners as a planning tool to understand the company’s value and how to enhance it over time.
How is Value Determined?
There are three approaches used by business valuation professionals to determine the fair value of a company. These include the income approach, market approach, and asset approach. Each method is appropriate for companies in different circumstances and are described below:
- Income Approach – Focuses on evaluating the cash flow benefits from investing in a company against the expected return for assuming risk and associated uncertainty.
- Market Approach – Determines the value of a company based on completed transactions of comparable companies (generally by industry). This approach is familiar to many since residential real estate is valued in a similar manner.
- Asset Approach – Determines value by measuring the fair market value of a company’s assets less its liabilities. Most often used to determine the value of a holding company or an underperforming company.
What Information is needed to Perform a Valuation?
While each situation is different, there are foundational items needed to commence the valuation process. These include the profit and loss statement, balance sheets for last five years, corporate tax returnsfor the last five years, and the balance sheet for the current year. In addition, copies of current year forecasts and projections are usually requested. Finally, information about the company’s products/services, list of assets including inventory and any liabilities, is also needed.
What is the Expiration Date?
Technically a business valuation does not expire. However, a valuation is designed to appraise the value of the company at a certain point in time. Key internal and external factors that impact the value of a company can vary significantly over time. So the more time that has passed since the valuation, the less accurate it will be and less likely to be accepted. Many estate planning attorneys will require an update if the valuation is more than six months old.
There are many reasons a business owner may want to conduct a valuation. Depending on your circumstances, there may even be one more appropriate valuation approach over another. Business valuations can be complex and require a qualified advisor to help you navigate the process. If your company needs a business valuation, Sikich wants to help! For additional information please contact Ray Lampner.