Like most business owners, you have probably invested a lot of energy into growing your business. And like other business owners, you probably hope to exit your business at some point in the future with enough money to ensure your financial security. When the time comes to sell your business, you’ll have to determine its fair market value (FMV) to ensure you’ll receive a fair price. Since it is a difficult undertaking to assess fair market value, the assistance of an appraiser who specializes in business valuations is crucial.
Different Approaches
Business valuation professionals will typically use a variety of approaches to determine the value of a business.
An asset-based approach basically looks at a company’s balance sheet. If the valuation is based on a going concern, the company’s assets (net of depreciation) are listed and its liabilities are then subtracted. Generally, the resulting “book value” is adjusted to reflect the current market value of the company’s assets.
Earnings-based approaches assume that a business’s true value lies in its future wealth-producing abilities. One common approach involves capitalizing past earnings using a rate of return that a reasonable buyer would expect on the investment.
Market-based approaches attempt to establish the value of a business by comparing it to similar businesses that have recently sold. This approach works well for most businesses except sole proprietorships, since finding public information on prior sales of like businesses is difficult.
IRS Approach to Valuing a Business
It also may be helpful to look at the factors the IRS considers when determining the value of a business for tax resolution purposes. The IRS typically weighs the following factors when attempting to compute the fair value of a business:
- The nature of the business and the history of the company
- The future prospects of the economy at large and the business’s industry in particular
- Book value and overall financial health
- Earning capacity of the company
- Dividend-paying capacity
- Goodwill or other intangible value
- Sales of the stock and the size of the block of stock to be valued,/p>
- The market price of stocks of corporations engaged in the same or a similar line of business.
Timing of the Valuation Is Important
As a business owner, it makes sense to have your business valued long before you intend to sell it. Why? If it transpires that your business’s valuation is lower than you assumed, you will have sufficient time to implement various changes in your business that can drive up its value.