Business owners essentially need to know the fair value of their company. This information is critical while planning to sell a company, designing an exit strategy, bequeathing the business to the owner’s kin, pursuing new partnerships, merging with another company, or managing ESOPs. These are just a few reasons to conduct business valuation.
Business valuation is part math, part research, and some may even say part highly educated guess! Several methods can be used for conducting business valuation. Ideally, accredited experts are hired to perform this exercise, as professional judgement is needed to:
- Predict a company’s financial performance
- Value proprietary technology or specialized knowledge possessed by a business
- Determine the potential for success vis-à-vis changing economic conditions
The three main approaches toward business valuation are:
- Asset-based approach – Through this approach, the business is valued by finding the difference between assets and liabilities.
- Income-based approach – In this approach, the value of the business is estimated to be equal to the current value of the economic income that is expected to be generated. This approach discounts or capitalizes expected returns at a rate of return that reflects investor risks and hazards.
- Market-based approach – The fundamental basis of this approach is that the fair market value of a company can be determined based on the prices paid by investors for stocks of similar, publicly traded (or private) companies.
Business valuation helps business owners take informed business decisions and design strategic plans. The process has many benefits including:
- Knowledge of company assets – The business owner gets information regarding the exact value of the company’s assets and does not need to depend on estimates. Business valuation helps in taking decisions regarding insurance coverage, required amount of investment, etc.
- Resale value – Business valuation showcases the true market value of the company. If the owner is contemplating to sell the company, then this process is necessary, as it gives the owner bargaining power.
- True company value – Business valuation not only considers simple data points, such as stock market value or profit numbers, but also takes into account historical data and income and valuation growth outlook. Therefore, business valuation reflects the true value of the company.
- Access to new investors – Business valuation can help business owners seek new investors. Potential investors would always insist on a business valuation report to understand the company’s prospects.
Business valuation also helps in setting long-term plans of the company. Valuations done previously can be used as benchmarks, based on which the company can strategize its growth plans.
Business valuation is a critical process that helps a business owner understand various components of a business, and hence, it is invaluable to the owner.