What is the Valuation of Your Business?

Many business owners believe that the value of their business is net profit, or gross sales, multiplied by some industry rule of thumb. It is not. In fact, using such a formula often results in a value determination that differs significantly from the actual value that could be determined by a qualified business valuation professional. An inaccurate value determination, whether high or low, generally leads to undesirable consequences. If too high, estate taxes will be excessive. Prospective investors or buyers will usually disregard a value that appears too high. If too low, the smart investor or buyer will take advantage.

Similarly, if you are involved in a dissenting shareholder or marital dissolution, you want to know that you are receiving fair value for your interest. Therefore, an exaggerated valuation at either end of the spectrum may not lead to desirable results for owners and interested parties.

The true value of a business is based on either tangible assets (real estate, machinery, furniture) or intangible assets such as goodwill, customer lists, trademarks and copyrights, distribution rights, non-compete agreements, outstanding management, physical location or name recognition. Often, a company's intangible assets are greater than the tangibles. However, it is in valuing the intangibles that one most needs a business valuation professional who has the necessary training, experience, and skill.

In valuing intangibles, the valuator must understand every aspect of the enterprise dynamics, including:

• Management capabilities
• Company strengths, weaknesses, and vulnerabilities
• Overall expectations for the marketplace
• Competitive environment
• Current and future prospects for the industry

All of these elements affect the risk of an ownership interest in a particular enterprise, and risk affects value.

The valuator must also analyze the financial health of the enterprise and assess its future profit potential. Generally, profitability translates into intangible value and/or goodwill, so a key part of the valuator's analysis will focus on making adjustments to determine a company's true profitability. Common adjustments include:

• Adding back to profits amounts for excess officers' compensation over and above the industry average
• Excessive depreciation on assets aggressively written down
• Non-recurring charges to expense

After a thorough analysis of the company's dynamics and financial health, the valuator must then select the most appropriate methodology from among the many used by the valuation industry, and apply a series of calculations and formulas to arrive at ultimate conclusions of value.