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Submitted By: Julie Miller on Jun 23, 2022 2:00:00 PM
Most business owners and attorneys know the basics of the business valuation process. For example, you might know that there are three approaches to value: the cost, market and income approaches. You might even know some of the methods that fall under these approaches, including the:
But experienced laypeople also understand that the process of valuing a business is not simply a matter of plugging numbers into these "black boxes" and having the answer spit out the other end. Instead, the valuation analyst uses professional judgment to arrive at a reasonable conclusion of value.
Factors to Consider
Arriving at a reliable value starts with the subject company's financial information, including tax returns and financial statements from the last three to five years. Valuators also consider forecasts, projections and business plans.
But a comprehensive valuation goes beyond the numbers. It includes site visits, management interviews and an evaluation of the nonfinancial factors that impact value.
Valuators rely on various professional standards and publications to guide them through this part of the valuation process. These tools help appraisers know what information to request and what questions to ask.
For example, the AICPA Statement on Standards for Valuation Services No. 1 suggests the following nonfinancial information to consider when valuing a business:
This list is similar to what's included in IRS Revenue Ruling 59-60, which addresses the valuation of closely-held stock for tax purposes. This ruling is also commonly referenced for nontax valuations.
Beyond These Four Walls
Many of the items valuators consider relate specifically to the subject company. However, valuation analysts also consider external factors that impact value. These factors affect every business differently, requiring appraisers to make subjective judgment calls. To illustrate, consider these four examples:
On the other hand, if the restaurant were located in a town with a prosperous economy—despite a weak national economy—the local market conditions might increase the value of the restaurant. In some cases, a severe, ongoing economic situation, like during the COVID-19 pandemic, can have a dampening effect on almost every business no matter where it's located.
Conversely, a business that operates in an industry with high barriers to entry might not be as concerned about new competitors entering the marketplace. For instance, a manufacturer of products made from tungsten, an expensive and volatile commoditized metal, might find itself in a good competitive position because handling tungsten requires specialized facilities and training.
Putting the Pieces Together
It's often said that valuation is an art as much as a science. Valuation analysts piece together various types of internal and external data to get a complete picture of how much a business is worth. The process requires more than dropping numbers into a black box. Like a trained artist, valuators use their professional tools, accepted methods and business experience to finesse the data into reliable value conclusions. Attorneys and business owners who understand what happens behind the scenes can facilitate the valuation process.
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