Many small company owners don’t know what their enterprise is worth, a practice that can amount to risky business.
A whopping 98% of small businesses polled by M&T Bank over the past two years didn’t know the value of their companies. This is especially troubling, given that for most business owners, their company is their most valuable asset.
“People whose home is their primary asset want to know what it is worth. If you open up a brokerage account, you want to know how much it’s worth. You’d never give your money to a financial advisor who told you to trust them while they invest it and never report back to you on what it’s worth,” said Travis W. Harms, who leads Mercer Capital’s family business advisory services group. “Just because your business is not liquid wealth, doesn’t mean it’s not real wealth.”
Here are five points to help entrepreneurs understand the importance of evaluating a business.
Valuation is critical to running a business, and selling it
Many business owners may be too overwhelmed with day-to-day operations to focus on having their company valued. Others don’t want to spend the money or simply don’t realize the importance of having an objective third-party measure of its worth.
A valuation, however, can be critical for many reasons. These include an impending sale, the issuance of stock options, succession planning, tax and estate planning, capital raising, implementing a buy-sell agreement, insurance needs or to obtain business funding, said Robert King, partner on the investment banking team at Crewe .
Say, for instance, you want to gift company shares to a family member. Understanding the company’s valuation is important for tax and estate planning purposes. Another reason to value the business is as a checkpoint so partners are all on the same page. Even if there’s a buy-sell agreement, there can be disputes about how a business is valued for the purposes of separation. Having realistic expectations for the business along the way can prevent a prolonged and messy fight over the company’s worth if the time does come for owners to part ways, Harms said.
Knowing your business’s up-to-date value is also important because many owners don’t plan to sell their business until a suitor comes knocking, said Brett Dearing, partner and exit planning specialist with the wealth management firm Cerity Partners. If you don’t have a current valuation, you’ll be at a disadvantage from a negotiation standpoint. You could either have an overly rosy outlook for your business, or conversely, be grossly underestimating its potential.
“A lot of business owners don’t understand the value of their business before they sit down with a buyer at the negotiating table,” Dearing said.
Certified experts exist to value your business
One of the best ways to find an expert to value your business is through one of three credentialing bodies.
The Accredited in Business Valuation credential is granted by The American Institute of Certified Public Accountants to CPAs and qualified valuation professionals who meet the requirements. There’s also a business valuation certification by the American Society of Appraisers. And the National Association of Certified Valuators and Analysts offers the Certified Valuation Analyst designation.
While having one of these certifications alone doesn’t guarantee an appraiser’s quality, it should be your baseline starting point given the level of expertise these designations require, business valuation professionals said.
The cost of calculating a valuation will vary
There’s no single answer to the question of cost because it depends largely on the size and complexity of the business, the scope of work required, and the purpose and intended use of the valuation, Harms said.
Given these parameters, an appraisal could cost anywhere from around $5,000 to around $50,000, according to valuation professionals. Be sure to be specific with the appraiser about the reasons you are seeking a valuation so they deliver what you’re asking for.
Some of the assumptions that go into a valuation for estate planning purposes or issuance of equity compensation could be decidedly different than for raising capital or selling a business, said King. “One size doesn’t fit all,” he said.
Business owners should update this asset value regularly
Depending on what you need the valuation for, it can be something you do annually or every few years.
It can also be done more frequently as you are trying to grow your business. M&T Bank offers a free digital platform that allows businesses to model how different outcomes would impact their valuation. It’s not an accredited valuation, but the service offers a baseline before you take that next step, said Jonathan Kolozsvary, director of new ventures at M&T Bank.
Valuing the business regularly can help you determine weak spots and make improvements. “If you go through the valuation process and the value isn’t quite where you want it to be, you can improve the valuation based on the areas identified,” said Tami M. Bolder, director at CBIZ Valuation Group. “It’s also helpful for general planning purposes,” she said.