June Energy Advisor: What is Your Business Really Worth?
Many companies are experiencing unprecedented growth as a result of the Marcellus Shale Play. Such success often leads to a very important fundamental question – What is my business worth?
As a business owner, you or someone else close to you will eventually need to ask that question. In order to answer that question, you will need a business valuation. There are many triggers that spur the need for a business valuation, including estate planning, estate compliance, buy-sell agreements, merger/acquisition, divorce, etc. Often, an owner simply wants to know what the business they built is now worth. When considering a business valuation, there are many things you should take into account.
Right Professional/Right Service
Not every professional (CPA, attorney, etc.) has the specialized credentials that are necessary to properly provide business valuation services. Among the most respected credentials is the Accredited in Business Valuation (ABV) designation, which is awarded to CPAs by the American Institute of Certified Public Accountants (AICPA). There are only 2,600 designees in the United States. Another well-regarded accreditation, the Certified Valuation Analyst (CVA), is awarded only to certified public accountants by the National Association of Certified Valuators and Analysts (NACVA). Only one percent of all CPAs in the United States have either the ABV or CVA credentials.
After finding a CPA with the above credentials, the next step is for you and that CPA to establish the appropriate level of service that the CPA will provide to you. A choice is made between a “calculation of value” and a “conclusion of value.” In a calculation of value, the CPA/valuation professional and the client determine in advance the valuation methods and approaches that will be utilized and the report produced is typically limited to providing the calculation itself. In a conclusion of value, the CPA/valuation professional is free to utilize any valuation approach/method and the report involves various sections, including company background, financial analysis, industry analysis, etc. as well as the results of the valuation itself.
Fundamental Valuation Factors
A sound valuation will be based upon all the relevant facts. The CPA/valuation professional then weighs all the relevant facts to determine their aggregate significance. The following are the fundamental valuation factors that need to be considered:
- History and nature of the business
- Dividend paying capacity
- Economic and industry conditions
- Intangible value
- Book value
- Prior equity transactions
- Earnings capacity
- Market price comparables
Once the above factors have been considered, the CPA/valuation professional will apply one or all of the following approaches:
- The asset approach determines the fair market value of the company’s tangible assets and liabilities but does not consider the company’s earnings or intangible value.
- The income approach measures the intangible value derived by the company’s earnings by applying capitalization rates and techniques.
- The market approach measures the company’s intangible value by comparing the company’s financial performance to market results for comparable companies (private company and/or public company).
Once a value is determined, sanity checks are performed to ensure the valuation makes sense. An example of one sanity check in an acquisition transaction would be to measure the expected term of a hypothetical financing arrangement to pay back the borrowed proceeds used for the acquisition. If the term is too short, the value may be too low. If the term is too long, the value may be too high.
Many business owners dedicate their careers and often their whole lives to running a successful business. They owe it to themselves to get a documented, substantiated, and accurate value. The final conclusion of the CPA/valuation professional should be tested and confirmed by the CPA firm’s quality control process so that you can be confident that you know what your business is really worth.
For more information or any questions, please contact the author: Gregory Farrell.