It can be challenging to determine how much your business is worth. However, if you want to use your business as collateral for a loan or if you want to sell your business then it is very important to come up with an accurate valuation. Much like selling a home, there is no exact science or magic figure that determines what your property, or your business, is worth. Instead you have to examine all of the facts and come up with a figure that you believe best represents the value of your business.
Four Valuation Methods
The four most common valuation methods include:
- Income Valuation: as the name implies, this method of valuing a business looks at the anticipated future income of the business. A formula is then applied that discounts future earnings to present day levels to come up with a fair market price for the business.
- Asset Valuation: an asset valuation looks at all the individual parts of a business, values them and adds them together to come to a fair market value. In other words, according to the asset valuation method, the total value of a business is the sum of all of its tangible parts. However, this method does not include things such as name recognition or customer goodwill that are intangible, yet valuable, to the existing business and potential buyers.
- Industry Formulas or Standards: some industries have general standards for valuing business. Some, for example, use the three year rule which values a business at three times the average income of the business over the past three years. Industry formulas and standards must be carefully reviewed if you choose to use this approach so that you are not undervaluing or overvaluing your business. For example, if the economy is coming out of a recession that hurt your business then your income over the past three years may not be truly indicative of how much your company is worth.
- Comparable Sales: another way to value a company is to consider the sales of recently sold companies. This is valuable information because it gives you information about how much potential buyers are willing to pay. However, it is important to carefully compare the comparable sales to your own business and to ensure that your price appropriately reflects the differences in your business and the comparable sales.
You may decide to use one or more of the above valuation methods when determining the value that you are going to assign to your business. For example, the income valuation approach and comparable sales approach may both be important to your price determination if you are going to sell your business. Your accountant and business lawyer can help you determine the fair market value of your business so that you are in a strong position to obtain a loan or to sell your business.
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