Business Valuation Methods

A Quick Guide to Business Valuation Methods

Let’s face it; the goal of many business owners is to build a company which can ultimately be sold for a large profit.  While this may be the end goal, how to go about doing this can be quite difficult.  This is why an entire industry has been created to deal with business sales and acquisitions.  Unfortunately, entrepreneurs are typically great at building businesses, but not always good at selling them.  Entrepreneurs tend to have so much invested in their businesses that they are not able to emotionally detach from the situation.   Hiring a business valuation consultant can help bridge this gap and often allow business owners to receive more money for their business than they would have received otherwise.  There are three primary business valuation methods.

Asset Method

When business valuation professionals use the asset method to value a business, they are looking strictly at assets to determine the value of a business.  The asset method takes a look at the actual assets of a business and uses them to determine a fair value for the business.  The trouble with this method is that assets do not always equal value.  For instance, if your company possesses significant intellectual property, these properties may not be considered assets.  They are more abstract ideas which could be very valuable for a potential business owner, but are not necessarily classified as assets.  This is why many business owners have issues with business valuation methods that focus only on assets and nothing else when determining the market value for a company.

Market Method

The market approach to business valuation uses the free market to determine the value of a business.  This method uses supply and demand principles to determine what is fair in terms of a sales price for both the buyer and seller.  To effectively complete this type of business valuation, it is important to find comparably valued companies which can be used to help determine the value of the business in question.  This allows valuation professionals to attach a market driven price to a certain company as opposed to a random number which has no correlation to the actual industry.

Income Method

The income method attempts to take into consideration the present value of the business as well as any potential risk that could be detrimental to the future earnings of the business.  This method of valuation takes the expected future earnings minus possible future risks to provide a valuation based solely on income.  To do this, this method uses Capitalization and Discounting to attempt to fairly value a business.  Simply put, Capitalization gives the buyer and seller a factor which can be used to determine future earnings to add to the present value of a business.  Discounting projects what future income will be on the front end to ultimately come up with a present value for a company.

If you have questions about selling your business, it is wise to enlist the services of a business valuation professional who can give you sound advice.  These professionals will be able to point you in the right direction in terms of which valuation method to use to sell your business.

Dale S. Richards is a third-party partner with American Gnuity who specializes in management, marketing, operation optimization & business valuation consulting as a Certified Valuation Analyst (CVA) with NACVA.

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