Many small business owners do not know what their business is worth, a practice that can amount to a risky business.
A whopping 98% of small businesses surveyed by M&T Bank over the past two years did not know the value of their businesses. This is especially troubling since for most business owners, their business is their most valuable asset.
“People whose house is their most important asset want to know what it’s worth. When you open a brokerage account, you want to know how much it’s worth. You would never give your money to a financial advisor who would tell you to trust them while investing it and never tell you what it’s worth,” said Travis W. Harms, who heads Mercer Capital’s family business advisory group. “Just because your business isn’t a liquid asset doesn’t mean it isn’t a real asset.”
Here are five points to help entrepreneurs understand the importance of valuing a business.
Valuation is crucial to running a business and selling it
Many business owners may be too overwhelmed with day-to-day operations to focus on evaluating their business. Others don’t want to spend the money or just don’t realize the importance of having an objective measure of third-party value.
However, an assessment can be critical for many reasons. These include an upcoming sale, the issuance of stock options, succession planning, tax and estate planning, raising capital, executing a purchase-sell agreement, insurance needs or raising corporate financing, said Robert King, a partner in Crewe’s investment banking team.
Suppose you want to give company shares to a family member. Understanding business valuation is important for tax and estate planning purposes. Another reason to value the deal is to serve as a checkpoint so partners are all on the same page. Even if there is a sale-purchase agreement, there can be disputes over how a company is valued for the purpose of separation. Having realistic expectations for the company can prevent a protracted and chaotic struggle for the company’s value when the time comes for owners to separate, Harms said.
It’s also important to know your company’s current value because many owners don’t plan to sell their company until a suitor knocks, said Brett Dearing, a partner and exit planning specialist at wealth management firm Cerity Partners. If you don’t have a current rating, you’re at a disadvantage from a negotiation perspective. You could either have too rosy prospects for your company or, conversely, grossly underestimate its potential.
“Many business owners don’t understand the value of their business before they sit down at the negotiating table with a buyer,” Dearing said.
Certified experts exist to evaluate your business
One of the best ways to find an expert to rate your business is through one of three certification bodies.
The Accredited in Business Valuation certification is awarded by the American Institute of Certified Public Accountants to CPAs and qualified valuation professionals who meet the requirements. There is also a business appraisal certification from the American Society of Appraisers. And the National Association of Certified Valuators and Analysts offers the Certified Valuation Analyst designation.
While either of these certifications alone does not guarantee a valuer’s quality, given the expertise required for those designations, it should be your basic starting point, business valuation experts said.
The cost of calculating a rating varies
There is no one-size-fits-all answer to the question of cost, as it depends largely on the size and complexity of the business, the scope of work required, and the purpose and intended use of the assessment, Harms said.
Given these parameters, a valuation could cost anywhere from about $5,000 to about $50,000, according to valuation experts. Make sure you tell the reviewer exactly why you’re looking for a review so they deliver what you’re asking for.
Some of the assumptions that go into an evaluation for estate planning purposes or the issuance of equity compensation could be significantly different than those used to raise capital or sell a business, King said. “One size doesn’t fit all,” he said.
Business owners should update this asset regularly
Depending on what you need the assessment for, this can be annual or every few years.
It can also be done more frequently when trying to grow your business. M&T Bank offers a free digital platform that companies can use to model how different scores would affect their valuation. It’s not an accredited assessment, but the service provides a baseline before you take the next step, said Jonathan Kolozsvary, director of new ventures at M&T Bank.
A regular assessment of the company can help you identify weaknesses and make improvements. “If you go through the valuation process and the value isn’t quite where you want it to be, you can improve the valuation based on the areas identified,” said Tami M. Bolder, director of the CBIZ Valuation Group. “It’s also useful for general planning purposes,” she said.