Small business valuation is the process used to determine the real value of a business. Since factors such as buyer motivation, market position, and even changing real estate values can all affect what a person could actually sell a business for, a small business valuation serves as more of an estimate than a concrete answer. Evaluating the market price of a business may be done for a number of reasons, including to prepare for a sale, apply for an expansion loan, or correctly calculate taxes and earnings.
There are dozens of methods that can be used for small business valuation. To a certain extent, the best method will greatly depend on the individual business. A company that has many assets but a low profit record may end up with a highly inaccurate small business valuation if an asset-only method is used. Similarly, a company that moves assets in and out quickly but posts tremendous profits could be severely undervalued using the same method. Generally, to determine the best small business valuation method, owners turn to business appraisers to choose the appropriate means and conduct the evaluation.
The value of a business is often a blend of its tangible and intangible assets. For instance, owning the building that the company operates out of can be a substantial asset, but may not be the reason why a business is successful. Having a highly talented workforce that is loyal to the company may add tremendously to the value of the company, but cannot be easily estimated, since it is an intangible quantity. Many business appraisers will try to consider both intangible and tangible assets when reaching a small business valuation estimate.
Some of the methods used in small business valuation include asset-only, liquidation, earnings multiples, and adjusted value. Asset methods often provide the highest estimate for businesses with poor profit levels, since they are based entirely on the inventory and tangible assets of the company. Liquidation estimates how much money could be raised by selling everything the business owns within a given period, such as a year, and may be used for companies considering bankruptcy. Earnings multiples take the value of annual earnings and multiply it by a reasonable amount to reach a sales price. Adjusted valuation methods simply compare assets to liabilities, and may be a good choice for companies trying to determine tax status or expansion possibilities.
Regardless of the method used, the actual value of a small business boils down to what a person is willing to pay for it. A desperate buyer may be willing to go well beyond the evaluation price, while a buyer who knows the owner is facing financial trouble may be able to take advantage of the situation to negotiate a lower price. Small business valuation can be a highly useful tool, especially when done by an objective appraiser, as it gives the owner a jumping-off point for negotiations.