Reasons for a Valuation
There are many reasons why an owner of a private company might require a valuation:
- To find out what your business is really worth. This is particularly valuable information if you are thinking of doing any kind of transaction, such as raising capital, borrowing money, or selling your business. Some business owners have insufficient information or unrealistic expectations with respect to the value of their businesses. Having this feedback may save you hundreds of staff hours (including your own time), legal fees and accounting fees in preparing and negotiating a transaction that is likely destined to fail. It may help avoid sharing confidential information with investors, only to be later disappointed by a transaction aborted due to a valuation gap between buyer and seller.
- Fairness opinions to support transactions. When you are negotiating a merger, passing the business on to your children, negotiating a Management Buyout, or undertaking certain types of corporate reorganizations, tax planning as well as legal contracts will require a value to be set on your business.
- Divorce is unfortunately a frequent trigger of business valuations, as part of splitting the family estate.
- Death may trigger a valuation, in order to calculate the basis for inheritance or estate taxes
- Bonus plans. Some bonus plans of private companies are tied to business valuations. A good way to motivate staff is to provide them with a percentage of increase in corporate value.
- Employee Stock Ownership Plans. A valuation may be used to set up an ESOP, and many firms that operate as ESOPs perform a valuation annually, to measure milestones, productivity, or establishing a price for entry or exit from the ESOP.
- Partnership changes. Adding a partner or buying out a partner usually requires a valuation
- Tax and estate planning. Certain more sophisticated estate planning vehicles such as “estate freezes” require valuations.
- A learning experience. A good valuation will help an owner better understand value drivers of his or her business, as well as how investors or a buyer will be likely to perceive the business.
Two of the more common methods for valuing small and mid-sized companies are the “Multiples” and “Discounted Cash Flow” (“DCF”) methods. Both require expertise and good judgment. There are more than thirty methods used to establish the value of a business, along with hundreds of items and issues that must also be considered.