The initial response to the question in the title really should be: “Why do you want to know the value of your business?” This response is not intended to be flippant, but is a question that really needs to be answered.
- Does an owner need to know for estate purposes?
- Does the bank want to know for lending purposes?
- Is the owner entertaining bringing in a partner or partners?
- Is the owner thinking of selling?
- Is a divorce or partnership dispute occurring?
- Is a valuation needed for a buy-sell agreement?
There are many other reasons why knowing the value of the business may be important.
Valuing a business can be dependent on why there is a need for it, since there are almost as many different definitions of valuation as there are reasons to obtain one. For example, in a divorce or partnership breakup, each side has a vested interest in the value of the business. The partner who is the owner wants as low a value as possible, while his/her spouse wants the highest value. Likewise, if a business partner is selling half of a business to the other partner, the departing partner would want as high a value as possible.
In the case of a business loan, a lender values the business based on what he/she could sell the business for in order to recapture the amount of the loan. This may be just the amount of the hard assets, namely fixtures and equipment, receivables, real estate, or other similar assets.
In most cases, with the possible exception of the loan value, the applicable value definition would be Fair Market Value, normally defined as, “The price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.” This is the definition used by most courts.
It is interesting that the most common definition of value starts off with, “The price…” Most business owners, when using the term “value,” really mean “price.” They basically want to know, “How much can I get for it if I decide to sell?” Of course, if there are legal issues, a valuation is also likely needed. In most cases, however, what the owner is looking for is a price. Unfortunately, until the business sells, there really isn’t a price.
The International Business Brokers Association (IBBA) defines price (“transaction value”) as, “The total of all consideration passed at any time between the buyer and the seller for an ownership interest in a business enterprise and may include, but is not limited to, all remuneration for tangible and intangible assets such as furniture, equipment, supplies, inventory, working capital, non-competition agreements, employment, and/or consultation agreements, licenses, customer lists, franchise fees, assumed liabilities, stock options or stock redemptions, real estate, leases, royalties, earn-outs, and future considerations.” In short, value is something that may have to be defended, and something on which not everyone may agree.
Price is very simple – it is what something sold for. It may have been negotiated; it may have been the seller’s or buyer’s perception of value and the point at which their perceptions coincided (at least enough for a closing to take place), or a court may have decided.
The moral here is for a business owner to be careful what he or she asks for. Do you need a valuation, or do you just want to know what someone thinks your business will sell for? Merger and acquisition advisors, like those at EastWind Business Solutions, can be instrumental in helping establish your business’ value or price.
Copyright: Business Brokerage Press, Inc.
Photo credit: vchal (via iStock Photo)