Valuation 101: What is a Business Valuation, and Why is it Important?

A business valuation is a critical tool for succession planning, whether you’re hoping to sell or looking forward to retirement. If you don’t have a good grasp of your business’s value, you may have false expectations for the future, or greatly underestimate how much your business could fetch on the open market. An accurate value can also help you identify tax-saving strategies. Here’s what you need to know about this important planning tool. 

When Might I Need a Valuation? 

Sooner or later, all businesses need a professional evaluation. The reasons for this might include: 

• You are planning to retire, and want to compare your exit options. 
• There is no active market to help determine the price of your business. 
• You need to determine capital gains. 
• You are planning to sell the business. 
• You are planning to transfer the business as a gift to a family member. 
• You are embarking on estate planning. 

How to Determine Business Value

As with all things, value is ultimately in the eye of the beholder. There are several different options for determining the value of the business, including: 

• Income approach: This model values the business based on its anticipated income. 
• Asset approach: This values the business based on the value of its assets. 
• Market approach: This approach looks at prior sales of this company, or a substantially similar one. It may not always be possible, especially if a business is unique in its industry. 

What About Determining Taxable Value? 

Determining the taxable value of a business is a little different, since you do not want to over-value the company, but you also do not want to land in trouble with the IRS. The IRS can challenge your valuation if it is not reasonable, so it is wise to enlist the assistance of a valuation expert. 

Can I Use an Old Appraisal?

You already have a lot to manage as a business owner. You may think the easiest way to handle valuation is to use an old appraisal and hope for the best. Don’t do this—especially if the old appraisal was done for a different purpose from that for which you seek an appraisal now. The valuation method will change depending on your purpose, and value always shifts with time. Your company may be a very different company than what it was even a few years ago. A new appraisal is more reliable, and gives you the most actionable information.