By: Mike Kottwitz, CPA, CVA
The value of a business is often a business owner’s most valuable asset. Despite this, many business owners do not have a clear idea of what their business is actually worth. Often, business owners may have ballpark value estimates based on the company’s historical sales or profitability along with a multiple that may or may not be reflective of their industry or the current market conditions. A formal business valuation, or even a lower-scope calculation of value, is the best way to estimate the value of a privately-held business.
Many times, we hear misconceptions that valuations are only useful in business purchase or sale negotiations or in situations when they are required, such as divorce, estate tax, and gifting scenarios. However, as valuation professionals, we recommend business owners become familiar with the value of their business, explore the many other uses for a valuation, and understand the benefits of knowing its worth.
Succession planning is often neglected by closely-held business owners who can frequently be busy managing the day-to-day operations of their company. The value of a business is a major component of any solid succession plan. Knowing the value of your company can assist in establishing buy-sell agreements, estimating life insurance needs, and projecting income into retirement after the business is ultimately sold. The earlier your succession planning process is started, the better your valuation professional can educate you on the areas that drive your company’s value. We can also help implement effective strategies to increase the value of your company over time and maximize the cash you receive after taxes.
Valuation professionals utilize three main approaches when performing a business valuation. These include the market approach, the income approach, and the asset approach. Each of these approaches have several underlying methods that can be utilized to determine an appropriate value of the company. There are pros and cons to each approach, but through discussion with our experienced valuation professionals, the most appropriate approach can be identified. Click on each of the drop-downs to learn more about each specific approach.
The market approach states that the value of a business can be determined by reference to comparable guideline companies for which actual transaction information is known. The information from comparable companies is made available since some may be publically traded or because they were recently sold and the terms of the sale were disclosed. Utilizing the ratios from completed sales or publicly traded stock prices, multiples can be applied to the subject company to determine the company value under the market approach.
The income approach determines the value of a business using one or more methods to convert anticipated cash flow or economic benefits into a single amount as of the date of the valuation. This approach is company-specific as it utilizes an actual or projected benefit stream of the subject company and converts it to a cash value utilizing a capitalization or discount rate, which represents the rate of return a reasonable investor would expect on their investment in the company. The benefit stream is often based on discretionary earnings, earnings before interest, taxes, depreciation, and amortization (EBITDA), or similar figures.
The asset approach determines the value of a business based on the adjusted value of its assets net of its liabilities. Any asset-based approach will need to involve an analysis of the economic worth (i.e. fair market value) of the company’s assets and liabilities, since the amounts on the company’s balance sheet may not reflect economic reality.
After determining the value of a business based on the approaches above, one or more discounts may be appropriate to apply, depending on the purpose of the valuation or the specific interest being valued. The two most common discounts are for lack of control and lack of marketability. Click our drop-downs to learn more about each common discounts.
Lack of Control
Discounts for lack of control are utilized in situations where the interest being valued is a minority, or non-controlling interest. It is widely accepted in the business valuation community that an investment in a privately-held company is worth more if the equity holder has a control position in the company. With control, the equity holder has the ability to dictate operational strategies and distribution of profits to the owners.
Lack of Marketability
Discounts for lack of marketability are commonly used to account for the lack of liquidity available to equity holders of private companies when compared to investments in publicly traded companies.
Both control and marketability discounts can range widely based on industry, the current market environment, company-specific factors, and other variables.
HBE has a team of Certified Valuation Professionals available to assist with business valuations, succession planning, buy-sell agreements, business purchase or sale structuring, due diligence, divorce proceedings, estate and gift planning, and consulting to help maximize the value of your business. If you would like more information or would like to speak to us regarding these services, please contact our office at (402) 423-4343 and ask to speak with a member of our Valuation Team.