what is business valuation

Key Takeaways:
  • The terminology used in valuation services —such as “valuation,” “evaluation,” and “calculation”— often overlaps but each term has distinct meanings and implications for the valuation process.
  • The reason for seeking a valuation and the intended time horizon are important factors that influence the choice of valuation approaches and methods.
  • The valuation process involves assessing the value of a business or asset for a specific purpose, influenced by qualitative and quantitative evaluations, and culminated through precise calculations.

 

Valuation is a practice that is often referred to, by clients and practitioners alike, by different terminology. Business owners may seek a “valuation” or an “evaluation” or even a “calculation” to determine the value of their holdings. 

Often, these terms have specific meaning in the minds of those who need the services, so it’s essential for practitioners and clients to get on the same page from the start as to the services the client is actually seeking. 

In fact, while each term means something slightly different, the terms are used interchangeably, and most clients are actually seeking a valuation. But it’s important to know how the terms relate to each other. 

A “valuation” is the technique of assessing the value of a business owner’s company, or a shareholder’s equity interest, or the property in an individual’s estate. So, the term “valuation” refers to the process of reaching a determination of value given a specific purpose for doing so. 

An “evaluation” refers to the qualitative and quantitative factors that are assessed during the valuation process to influence the ultimate determination of value. Evaluation includes the process of examining financial records and the condition of a business or property, and determining the best methods to use for the valuation within the context of the purpose for which the valuation is being sought. 

A “calculation” simply refers to the mechanics of the valuation process, including the methods used and the assembling of data to reach a determination of value. 

A Deeper Dive 

Valuation 

A valuation discussion between a business owner and a valuation professional generally will start with a few basics: 

  • What is the reason for the valuation? Knowing your goal assists the valuation professional in determining the best valuation approach and methods to use, as well as the standard and premise of value. If you are seeking the valuation to estimate your company’s value because you want to sell it and retire, one set of approaches and methods will be appropriate. But if you are a shareholder seeking a valuation of your interest in a company for estate planning purposes, or for a buy/sell agreement, another set of approaches and methods will be best. 
  • What is your time horizon? Are you planning to sell your company within a year? Or are you doing advance planning for an exit that is five to seven years in the future? The timeline matters and will help the valuation professional determine which factors and approaches will get you to a realistic determination of value. If the timeline is long, the valuation will also provide a roadmap to changes you can make that will enhance the value of your business when it is time to exit. 

Evaluation 

Consider the evaluation and planning phase for a business that is seeking a business valuation. The valuation professional will request relevant documents that provide quantitative and qualitative data, such as financial statements, a quality of earnings report and human resources records, among others. They will also perform economic and industry research, visit the company and interview management, as well as consider the best valuation approaches and methods. 

Some of the issues the valuation professional will deal with during the evaluation phase include: 

  • Client interview, where your valuation professional will discuss compiling a five-year analysis of the company’s financials and ask you for more detailed information to give context to some of the numbers. The interview will also uncover information that is company-specific or industry-specific, and which could impact the valuation. 
  • How current interest rates impact the company. 
  • How the level of the company’s debt may impact the valuation. 
  • Whether the company is going through a growth phase and, if so, how it will fund additional growth – with financing or cash on hand. 
  • The state of the national economy and current industry conditions. 
  • The regulatory environment if the company is highly regulated.  
  • Workforce and labor participation and availability. 

Calculation 

During the calculation phase, the results of the evaluation phase will be analyzed and their impact on the valuation determined. During this phase, any premiums and discounts on the value will also be applied.

Questions? 

Valuation is a process with multiple steps and a mountain of documentation that can be daunting if you have never been through it before. To the extent possible, your valuation professional will coordinate with other allied professionals who work with your firm, including accountants and attorneys, to make the process as seamless as possible. Additionally, digital document exchange tools will be used to ease the exchange of data. 

Your valuation professional will meet with you after the draft valuation report is finished to help you understand the assumptions, approaches and methods that were used, and how the data gathered during the evaluation phase was used.  

If you would like to discuss a valuation of your business, your interest in a company or your personal property for estate planning purposes, contact an Adams Brown advisor.