Business value is not a specific number and there is no one absolute value that defines it. But rather business value is range and varies greatly based on assumptions used and factors considered. Market value is one type of business value.
Fair market value is the price at which a business changes hands between a willing business buyer and seller. It is important to keep in mind there is no one true value for a business because the value of a business is influenced by many factors. So rather than think of the value of a business as an absolute number, one should think of it as a range. There are many reasons owners value businesses including buying and selling businesses, employee stock ownership plans, estate taxes, business equity transfer, financing and so on. Business valuation is also required for tax purpose when a business transferred to the next generation.
One place to start is to engage a professional business appraiser. Appraisers tend to conduct detailed analysis and use intrinsic valuation techniques rather than using rules of thumb because it tends to be overly optimistic. Business appraisers have their pulse on macroeconomic and microeconomic changes effecting the economy and they can help business owner’s trade-off terms with cash when negotiating a term sheet.
There are two factors that affect small business valuations the most namely cash flow and the value of assets it holds. Cash flow is the amount of cash the business generates. Other factors that influence a business include Supply and demand, Interest rates, nature and history of the business, location of the business and so on. When the number of businesses for sale is large the value tends to be lower and vice versa. If interest rates go up money gets tighter, interest payment becomes larger and the value of the business goes down.
Some additional considerations for business valuation include:
- Financial condition of the business. The best measure for this is the book value. Book value is the total assets minus total liabilities of the business. The book value of a business can be determined by analyzing the balance sheet and income statement.
- Ability of the business to generate cash, pay dividends and so on.
- Prior sales of businesses in the area. In the best case there would be similar businesses in the geographic location that can be used as comparable.
Following is a checklist of documents a business owner requires to value a business.
- Financial statements which includes balance sheets, income statements for up to the last five fiscal years.
- Income tax returns for the last five years.
- Equipment list, depreciation schedule, Accounts Receivable, Accounts payable, inventory list, lease, and prepaid expenses.
- List of stockholders or partners, with number of shares owned by each or percentage of each partner’s interest.
- Description of business including competitive analysis and factors that make the business unique.
- Regulatory filings, associations the business belongs to and relevant trade publications.
- List of patents, copyrights, trademarks, and other intangible assets.
- Is the business at risk from new regulations or legislation.