Purpose of Business Valuation
Valuing a business is a crucial step for business owners, investors, and shareholders interested in buying or selling a company, or simply assessing the worth of a company for growth, future plans and goals, or tax purposes. There are various methods for doing so, and the valuation will depend on a number of factors, including industry, goals, and market status. A comprehensive business valuation will help parties determine whether a sale or purchase is feasible, practical, or even desirable.
In this blog post, we’ll explore some of the different valuation methods and factors to consider.
Initial Matters in Due Diligence or When Drafting an LOI
Company Financial Statements: As an initial matter, assess a company’s financial statements, including income statements, balance sheets, and cash flow statements. These documents provide a general overview of a company’s financial standing with insight into costs, profits, and losses.
Market Research: Research the industry and market trends to assess the business’s growth potential and risk factors. This information will play a significant role in determining the valuation.
Typically, a business valuation will look at a combination of the methods below to provide a more comprehensive snapshot of a company’s overall health.
Income Approach – This approach is based on the idea that the value of a business enterprise or property is determined by the income or cash flow likely to be generated by a business. For example, this may include looking at how much a current investor might anticipate an investment to be worth in the future based on a business’ income.
Market Approach – This approach involves using similarly situated businesses for comparison to determine the value that the particular market (or industry) would set. This is typically more easily accomplished for businesses that have sales information more readily available in a competitive market. More niche or unique businesses may have more trouble assessing market value this way since it may be harder to find appropriately comparable businesses.
Cost Approach – This approach values a company based on the cost or worth of its various parts, or assets. This method looks at a company’s assets, liabilities, and costs associated with operation. Because of the somewhat simplistic view of a business, this method should be used as a reference in conjunction with another more comprehensive valuation.
Other Factors to Consider
Industry and Market Conditions: The business sector and current market state can significantly impact a company’s value. Other factors like amount of competition and industry demand should also be considered.
Economic Factors: Macro and microeconomic conditions, interest rates, and inflation should be considered. Times of economic depression or high interest rates can significantly impact either a buyer or seller’s ability to complete a deal.
Growth Potential: Related to general economic and industry conditions, a company’s growth prospects, including market demand, competition, and expansion opportunities may also be limited or enhanced by external factors.
Company’s Financial Health: Evaluate the company’s financial stability. This includes looking at debt, liquidity, tangible assets (such as real estate, equipment, etc.), and profitability.
Intangible Assets: Consider the value of intangible assets such as patents, trademarks, brand reputation, and intellectual property. Other corporate documents including contracts with employees, vendors, or customers may also be considered. These factors can contribute to or subtract from, a company’s future profits and success.
Employees and Management: A competent and experienced team can positively influence a business’s value. Evaluate any agreements with employees, benefits, and employee experience and education to see how the company retains or attracts high level talent. Experienced industry professionals can be a valuable asset to growing and sustaining a company.
Legal and Regulatory Factors: Investigate any legal issues, including pending litigation, violations, or other regulatory issues that could impact the operation of the business. Evaluate any necessary licenses for the continued conduct of business.
Whether you’re a business owner, advisor, investor, or potential buyer, a thorough business valuation can lead to better financial outcomes and strategic decisions for all involved parties.
The attorneys at MLMW regularly work with Buyers and Sellers in mergers and acquisitions from the inception of a deal through its closing and post-closing transitioning and are available to work with businesses and individuals to prepare their business for sale or in purchases.