Valuation is the process of determining the current value of a business. Business owners may need to understand the value of the business if there is an imminent sale, acquisition or merger. When on boarding new investors, to determine the correct value of collateral that could be used when seeking financing and for internal decision making purposes. Business valuation experts have different ways of valuing businesses based on their:
- structure,
- size,
- management team,
- complexity of operations,
- nature of business,
- future prospects of the business and
- valuation of similar businesses in the market.
Today, we will bust the Myth Of Fair Business Valuation among business sellers.
In most cases, business experts and brokers argue that a business must be fairly valued. And then priced especially when an acquisition, sale or merger is imminent. Given that there are different valuation methods, what is the fair value of the business? And what should be considered during the valuation? What is the myth of fair business valuation when Selling a Business?
The myths of fair business valuation
The Fair Market Value (FMV) of a business can be defined as a hypothetical value of a business. This is based on its assets and the prevailing market realities. In most cases, the Fair Market Value is usually different from the transactional value of the business. The transactional value is the amount that sellers are willing to accept. And willing buyers are willing to pay to acquire a business. The transactional value could be relatively higher or lower than the fair market value. And they may also differ from one buyer to another.
In most cases, professionals will make certain assumptions when valuing businesses. These assumptions are usually subjective. And are dictated by the valuation expert’s understanding or interpretation of the prevailing market realities. In such a case, the figure arrived it is as good as the assumptions underlying the valuation. A change in the assumptions would therefore result in a completely different value. If a business owner used two independent valuation experts, they would arrive at completely different values. Even under similar market conditions.
What factors affect the value of a business?
The management team, the size of the business, the complexity of business operations and the business structure have an effect on the value of the business. But there are two major determinants of the selling price: the buyer and the method of sale. The buyer’s offer price is an inherent indicator of how much they think the business is worth. This may be based on their research and experience in the market. Most valuation experts do not consider this when coming up with the value of the business.
Method of sale
The method of sale can result in a 20 to 40 percent change in the value of the business. Why is this so? A payment plan must consider the inflationary effects and future conditions. And could therefore push up the value of the business. Therefore, a buyer who is paying cash will end up paying a lower price compared to one who is staggering the payments over a period of time. If the sale is done through a competitive bidding process, the business owner may end up getting more for the business. These factors are not considered during the determination of the asking price.
Personal goodwill
The personal goodwill of the business founder is usually considered when valuing the business. This personal goodwill includes personal relationships, talents, passion, skills and the personality of the founder. This goodwill cannot be transferred from one business owner to the other and while it may have had a great impact on the success of the business, the lack of transferability means that their absence will diminish the value of the business to its new owner. Such factors should therefore not be considered when valuing the business.
Businesses must note that we can question the accuracy of the value of all illiquid assets. Because, the accurate value of an asset can only be determined through an exchange. In practice, the accounting professionals in a business usually use value of similar assets in similar businesses to determine the book value of the assets or use a certain percentage to appreciate historical figures with each passing period. It is therefore possible for the assets to be over or under valued and therefore, what may be considered as the true value of assets is actually an estimate.
Conclusion
Business owners need to understand that the Fair Market valuation of a business is more hypothetical than practical. They should therefore be open to negotiations and differences in interpretation of the business value. The value of the business is also subject to drastic changes. This is with respect to market conditions and interest from investors.
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