Updated: May 21, 2022
There are plenty of details behind the sticker price of something as complex as a business. If you are looking to purchase an existing business, you will want to know the method the seller used to come up with the target company’s valuation. There are other situations that necessitate a thorough understanding of the valuation of a business. Our blog will go over three prevalent methods for coming up with a company’s valuation.
Let’s say you and your business partners agree to sell your business today. What’s the liquidation value of your company’s assets? If you were to assess the capital gains you would receive for each asset owned by your business, you would calculate the liquidation-based valuation of your company. This method of business valuation will not likely get you a very high figure, but it can be useful.
The other main type of asset-based valuation is referred to as the “going-concern” approach. The going-concern method presumes that your business will exist indefinitely and continue to gather goodwill. If your company has trademarks, you probably know a lot about goodwill, or the valuation of your company’s intangible assets. Other than adding goodwill to a company’s valuation, the going-concern method subtracts liabilities from tangible assets. This type will often warrant a much higher valuation than the liquidation-based approach.
Many argue that a more accurate way to come to the valuation of a company is to calculate future profits. Within the income-based approach to business valuation, there are two main ways to come up with a number. Business owners may take either past cash flow and divide it by the capitalization rate or analyze a company’s financials to come up with the best estimate of its future cash flow. Then, using the discounted cash flow (DCF) method, divide that number by the capitalization rate. Each way has its own advantages and disadvantages.
Fair Market Value
Real estate comparables are crucial when determining the fair market value of real property. What have other properties, with many similar characteristics, sold for recently? What about other properties in the same municipality or area? If you’re selling a house, you might even be able to compare other homes on your street. The principle to determining the fair market value of a business interest is similar. If your business pays taxes to the IRS, you probably already have a good idea of the current fair market value. Using this method to value your business is difficult for sole proprietors.
Which One Should You Use?
Different situations warrant different valuation methods. For instance, you will want an approach that produces a larger figure if you are the one selling. The other party, however, will naturally disagree. While everyone may come to an agreement on one simple method, the parties involved will typically negotiate to some sort of median valuation that takes into account multiple types.
It takes an experienced and knowledgeable business attorney to help you determine the optimal method to use and make sure all legal considerations are addressed. Monahan Law Firm routinely helps business owners navigate complex commercial transactions, including business divorce and sales. How can we help you and your company?