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What is the value of your business?

Many business owners believe the value of their business is net profit, or gross sales, multiplied by some industry rule of thumb. It’s not. In fact, using an industry rule of thumb formula often results in a value determination that differs greatly from the actual value that could be determined by a qualified business valuation professional.

An inaccurate value determination, regardless of whether it is high or low, generally leads to undesirable consequences.

Too high: estate taxes will be too high and savvy investors or prospective buyers will usually disregard a value that appears too high.

Too low: you can be sure savvy investors or prospective buyers will recognize it and take advantage.

Likewise, if you are involved in a dissenting shareholder action or divorce, you certainly want to know you are receiving a fair value for your interest. Thus, a valuation that is high or low may not lead to desirable results for owners and interested parties.

The true value of a business is based on two kinds of assets: tangible and intangible.

Tangible:

Real estate

Machinery

Furniture

Intangible:

Goodwill

Customer lists

Trademarks

Copyrights

Distribution rights

A superior management team

Non-compete agreements

Physical location

Special processes

Name recognition

Quite often, the value of a company’s intangible assets is much greater than the tangible assets. Valuing intangibles, however, is where one needs the services of a qualified business valuation professional: it requires a careful analysis of many aspects of a business enterprise and requires skills acquired through specialized training and experience.

To value intangibles, the valuator must understand every aspect of the enterprise dynamics, including:

Management capabilities

Company strengths, weaknesses and vulnerabilities

The competitive environment

Overall expectations for the marketplace

Current and future economic prospects for the industry

business

All of these elements affect the risk of an ownership interest in a particular enterprise, and risk affects value.

The valuator must also analyze the financial health of the enterprise and assess its future profit potential. Generally, profitability translates into intangible value and/or goodwill, so a key part of the valuator’s analysis will focus on making adjustments to determine a company’s true profitability. Common adjustments include:

Adding back to profits amounts for excess officers’ compensation over and above the average for the industry

Excessive depreciation on assets aggressively written-down

Non-recurring charges to expense

After a thorough analysis of the company’s dynamics and financial health, the valuator must then select the most appropriate methodology, from among the many utilized by the valuation industry, and apply a series of calculations and formulas to arrive at the ultimate conclusion of value. The process is complex and time consuming, but necessary to determine the true value of a business.