Business valuation is the process of determining the overall value of a particular business or company. Determining the exact business value can often be complicated, even for small businesses and partnerships.
However, an accurate approximation of a business’s total worth can be determined from:
- The business owner’s own accounting records
- Input from a professional, such as an expert analyst, lawyer, or appraiser
- Economic indicators, including assets owned by the company, cash flow, and earnings of the company
The business laws in each state may have different rules when it comes to determining a business valuation. The exact calculations and valuation methods may also depend on other factors, such as the type of business involved and the purpose of the valuation.
What is the Purpose of a Business Valuation?
The first step in a business valuation is identifying the purpose for which you need it. You may need a business valuation for an acquisition or sale, litigation, taxation, insolvency, or business disputes. The purpose of a business valuation depends on the particular circumstance.
The valuation conclusion under one standard of value may be significantly different than one reached on another standard of value. Be aware of this when you compare the conclusions of valuations or when reviewing valuation reports prepared for purposes other than your current issue.
What are the Types of Business Valuations?
There are generally three business valuation approaches:
- Asset approach
- Market approach
- Income approach
The asset approach is based on the economic principle that a business is a combination of assets and liabilities which can be used to paint a picture of a business’s value.
The market approach of a business’s value uses signs from the real market to determine how much a business is worth by comparing similar businesses to create a reasonable sale price.
The income approach looks at the business’s future earning expectations to determine the value of the company.
Additionally, financial considerations used to determine a business’s value include non-financial considerations, such as the business’s location or brand name. A business’s location and brand name are often considered and included in the valuation of a company in order to achieve the most accurate value.
What is Standard of Value?
The standard of value describes the type of values being measured. The following values are relevant standards in business valuations:
- Fair market value: Fair market value is the price at which property could change hands between a buyer and a seller.
- Fair value: Fair value is the price that would be received when selling an asset or the price paid to transfer a liability in a transaction. In a legal context, the fair value applies to certain specific circumstances which change from state to state.
- Investment value: Investment value is the specific value of an investment to an investor based on certain requirements. Investment value reflects the circumstances particular to a buyer or seller. Investment value may differ from fair market value, as some buyers may realize greater economic benefits from one asset than other buyers.
- Intrinsic value: Intrinsic value is the amount that an investor considers to be the real worth of an item based on an evaluation of available facts. Intrinsic value is a judgment of value based on perceived characteristics of the investment.
Depending on the type of case and jurisdiction, standards of value may be defined by statute. However, case law may provide more guidance about standards of value that should be used in particular situations. Oftentimes, case law outlines certain exceptions and modifications to standards of value.
What are Levels of Value?
Levels of value consider the ownership characteristics of a business. Degrees of control and marketability are considered. Levels of value are:
- Controlling interests: The control level of value for a business represents what the company would be priced at if the company and all of its interests were sold. A controlling owner has the ability to sell the company and make decisions about business affairs.
- Minority interest: Ownership of less than a majority number of voting units is considered a minority interest. Minority owners cannot control company policy or make decisions on behalf of the company. Minority interests limit an owner’s ability to control the affairs of a business.
When Is Business Valuation Necessary?
Business valuation becomes necessary in many different situations, especially where the overall worth of the business is in question. Some examples of instances where business valuation may be needed include:
- Buying or selling a business
- Transferring a business in a will
- Dividing up business assets in a divorce
- Filing for business bankruptcy
- For business tax purposes
Also, a business owner may wish to conduct a business valuation from time to time in connection with performance evaluations or similar reviews. A periodic business valuation can help determine whether it is profitable to continue the business operations and help identify possible areas of improvement for the company.
How Does the New Tax Law Affect Depreciation?
The Tax Cuts and Jobs Act introduced additional benefits for the accelerated depreciation of used assets. The old law, which applies to assets acquired on or before September 27, 2017, provides a 50% first–year deduction, but only for new assets. The new tax law provides a 100% first-year deduction that can be used on both new and used assets. Depreciation starts to phase down by 20% per year in 2023.
These changes change the way that a company’s finances look in year-to-year comparisons. Additional tax benefits may affect how a company invests its capital assets. When predicting future cash flows, it is necessary for businesses to consider these differences in the company’s past and future capital expenditures. Large depreciations can make it seem like a company has lost more money than it did in past years.
What If I Have a Dispute Over a Business Valuation?
While business valuations may be necessary for the company, they can also be a source of legal disputes in many cases. For example, a business valuation may involve disputes with other parties, such as:
- Beneficiaries who may be receiving some or all of the business assets
- Insurance companies
- Creditors and other types of financial lenders
Business valuation methods can involve disputes over:
- The actual value of the business
- Tax matters
- Business shares, especially in the distribution process during business wind-up of a joint-venture
In order to protect the company and its members from economic losses, it is generally best to include some provisions regarding business valuations within the company bylaws or operating rules. Also, whenever a contract is made in connection with the business, the parties may wish to include a clause addressing business valuation matters. This can help to avoid disputes and provide written records in the event that a lawsuit arises.
Do I Need a Lawyer to Assist Me With Business Valuation Issues?
Business valuation laws can be complex and will also vary from region to region. If you need assistance with business valuation issues, you may wish to hire a business lawyer for advice. Your attorney can help you determine how best to conduct a business valuation so that you obtain accurate results. In the event of any legal disputes or lawsuits, your lawyer can help represent the company in order to protect the company’s assets and properties.