Valuation is the process of determining the current value of a business. Business owners may need to know their business’s value if a sale, acquisition, or merger is imminent. When bringing on new investors, it’s important to determine the correct value of the collateral available for financing and internal decision-making. Business valuation experts use different valuation methods based on factors such as:
- structure,
- scale,
- Management Team,
- Operational complexity,
- Nature of business,
- The future prospects of the company and
- Valuations of similar businesses in the market.
Today, we’re debunking myths about fair valuation among business sellers.
In most cases, business experts and brokers agree that a fair valuation of a business is essential. This is especially true when a business is about to be acquired, sold, or merged. Given the varying valuation methods, what is the fair value of a business? What factors should be considered during the valuation process? What are the myths surrounding fair valuation when selling a business?
Misconceptions about fair corporate valuation
The fair market value (FMV) of a business can be defined as its hypothetical value. This value is based on the business’s assets and current market realities. In most cases, fair market value is different from the transaction value of the business. The transaction value represents the amount the seller is willing to accept, and the price the buyer is willing to pay, for the business. The transaction value may be relatively higher or lower than the fair market value, and the fair market value may vary between different buyers.
In most cases, professionals make certain assumptions when assessing a business’s value. These assumptions are often subjective and depend on the appraiser’s understanding or interpretation of current market realities. In such cases, the resulting figure is only as reliable as the assumptions underlying the valuation. Therefore, changing assumptions can result in a completely different valuation. If a business owner hires two independent appraisers, even under similar market conditions, they may arrive at completely different values.
What factors affect corporate value?
The management team, company size, operational complexity, and business structure all influence a company’s value. However, two primary factors determine the sale price: the buyer and the method of sale. The buyer’s offer is an intrinsic indicator of the company’s value. This is likely based on their research and market experience. Most valuation experts don’t consider this when assessing a company’s value.
Sales method
The method of sale can cause a 20% to 40% change in a business’s value. Why? The payment plan must account for inflation and future conditions. This can inflate the business’s value. Consequently, a buyer paying in cash will ultimately pay less than one paying in installments. A sale through competitive bidding could ultimately result in a higher profit for the business owner. These factors are not considered when determining the asking price.
Personal goodwill
When assessing a business’s value, the founder’s personal goodwill is often considered. This personal goodwill includes personal relationships, talents, passion, skills, and the founder’s personality. This goodwill is not transferable from one business owner to another. While it may have significantly impacted the success of the business, its lack of transferability means that its loss reduces the business’s value to the new owner. Therefore, these factors should not be considered when assessing a business’s value.
Businesses must be aware that the accuracy of the valuation of all illiquid assets may be questioned. The precise value of an asset can only be determined through exchange. In practice, accounting professionals typically use the values of similar assets in similar businesses to determine the book value of an asset, or apply a percentage to historical data for each period. Consequently, assets may be overvalued or undervalued, making the so-called true value of an asset only an estimate.
in conclusion
Business owners need to understand that a company’s fair market valuation is more hypothetical than actual. Therefore, they should be open to interpretations of their business’s value and accept that there will be negotiations and disagreements among various parties. Business values can also fluctuate dramatically, depending on market conditions and investor interest.
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