Dennis Covington | Managing Principal
- There are at least 7 different ways to value a private business: Here we will explore Liquidation Value, Market Value, Fair Market Value and Owner’s Value.
- Market value is a technique for showing how your business will look to different types of buyers. Using this method, you can start to zero in on which type of buyer is right for your company.
- Too often businesses are liquidated when they could have been saved with an intervention by an astute owner or advisor.
In Part 1, we looked at three common business valuation methods: Financial or Investment Value; Strategic Value and Intangible Asset Value. Here we’ll look at four more: Liquidation Value, Market Value, Fair Market Value and Owner’s Value.
Let’s start with one of the most common: Liquidation Value.
4. Liquidation Value
This value is the sad one. Remember the enterprise we talked about in Part 1–the business had 80 percent of its revenue in one basket—with one big customer—and that customer was looking at other suppliers?
Fast forward to a year later when the large customer decided to move its business to another supplier. There is a good chance that this $5 million business won’t be economically viable at $1 million. The owner at this point has no alternative but to liquidate the assets and try to stay out of bankruptcy.
When you are in this situation—there might be no buyer or, even worse, the business could easily be at risk. Too often businesses are liquidated when they could have been saved with an intervention by an astute owner or advisor.
5. Market Value
Market value is the range of values a company could sell for. This is what a buyer is likely to offer and the terms that the buyer might use. Market value is a technique for showing how your business will look to different types of buyers. Using this method, you can start to zero in on which type of buyer is right for your company.
When doing a financial plan for your business, it’s often a good idea to use a computer program that allows for various values and outcomes. This way you get to see what the range of outcomes could be for your business.
Market value is what real buyers are willing to pay for a business. You’ll really never know what the true market value of a company is until you actually try to sell it.
6. Fair market value
If you go to a valuation expert, you’ll get an estimate of the prices that a willing buyer and willing seller would agree to.
The truth is that fair market valuations are very often wrong. When Mr. Market gets ahold of a business, there will be a completely different set of valuations used. The value from a fair market valuation will either be higher or lower than the market value.
Fair market valuation is important when businesses are being transferred to families or when there is an ESOP (Employee Stock Ownership Plan) involved. Both scenarios require a fair market valuation as part of the business transfer process.
7. Owner’s Value
This is the most dangerous value of all. Owners will almost always value their businesses at a significantly higher price than any buyer is willing to pay. The fact is most businesses will not get the owner to retirement without additional income and savings. You need to understand that investment real estate and qualified retirement plans are crucial if you ever want to leave your business and never have to work for someone else.
Remember to factor taxes in the equation
As an entrepreneur planning for retirement, knowing what the tax bite will be is another determining factor in whether the business is valuable enough for retirement. The difference can be as much as 30 to 40 percent of the proceeds left over from the initial sales price.
You will also want to factor in the closing costs of a transaction. It’s not unusual for 10 to 15 percent of the sales price to be eaten up by business brokers, accountants and lawyers.
The challenge of valuing a business is knowing what the enterprise is worth to someone else. Sometimes it’s best to work on increasing value and finding ways to move into a more attractive value world before selling. The more informed you are, the better your business exit will be both from a financial and an emotional perspective.