Valuation Methods for Your Business

There is no one correct way to value a business. Facts and circumstances affect valuation, and for many owners, the best way to value their business is the result of combining several or more methods. Even the IRS has maintained that no fixed formula is universally applicable.
In legal documents that require business valuation for future transactions (such as a buy-sell agreement to transfer the business after the death of an owner), the appropriate valuation methodology and the person or entity to perform the calculation should be clearly defined in advance.
This will generally result in a more satisfactory (and less contentious) valuation for all parties.
Valuation methods can include:
1. Book Value: Typically calculated as ‘Assets minus Liabilities’. This is the simplest method of business valuation. But in many cases simple book value needs to be adjusted to more approximately reflect fair-market value.
2. Formula Valuation: Valuation by means of a formula can take many variations. The two most frequently used formulas (as considered by the IRS) are:
a. Future Cash Flow: This method looks at the present value of anticipated future income or cash flow generated by the business. In effect, the valuator capitalizes the company’s current earnings.
b. Capitalization of Earnings: This method is well-suited for valuing a company whose earnings can be reasonably predicted (constant earnings, growing earnings, or intermediate-term growth followed by constant earnings).
3. Appraised Value: Appraised value is accomplished through a third party.
4. Business Owner’s Estimate: The agreed-upon value is just that. It is the owner’s best estimate of what their business is currently worth.
Where to Begin
Regardless of your own retirement plans, knowing what your business is worth makes good business sense. Establishing the value of your business, however, is only part of the process. Your planning objectives are important in determining what other parts of the process are needed. This may include legal documents to establish business succession arrangements and funding of those arrangements through life insurance or other means.
Want to learn more about the value of your business? Contact Covenant Consulting Group.