The Types of Business Valuations

Posted by Rock LaManna

A valuation is essential for engaging in sales negotiations


Most business owners know they need a valuation to sell their company, but they’re a little fuzzy on the different types of business valuations.  Discover two valuation options, and how they can best be used to sell your business.

I’ve ordered countless valuations for clients, but for a true deep dive into valuations, I turn to Darren Mize.  Darren is an Accredited Senior Appraiser with GCF Valuation, Inc., and he shed some light on two types of valuations often used by owners looking to sell.

Deciding Between the Two Types of Valuations

Both of these particular types of business valuations accomplish the goal of determining your company’s value. However, as Darren explained, the level of detail is vastly different.

1. Calculation of Value - A calculation of value is a less formal valuation summary for an owner who is considering selling their business.The report includes your basic company information, a brief financial summary, and a brief summary of valuation methods used to create your final report.

While it doesn’t necessarily follow all the uniform standards or provide the level of detail compared to a more in-depth valuation, it can help you get a solid sense of a business’s value  -- often at a significantly reduced rate.

Because a calculation of value doesn’t provide the depth of some other valuations, it is better suited for owners in particular situations:

* It can help a buyer and broker come to a fair selling price.

* It can reveal areas in which an owner might need to improve before officially putting their business on the market.

* It’s a relatively inexpensive way to gauge the marketplace.

2. Complete Summary Appraisal - A complete summary appraisal is a more in-depth valuation report that follows the uniform standards of professional appraisal practices.

With an extremely high level of detail, a complete summary appraisal may seem like overkill. However, certain scenarios require you to conduct a full valuation that is recognized by the Association of Accredited Appraisers.

* It’s ideal for owners of large businesses that generate more than a million dollars each year, and who are planning to sell 100 percent of the business.

* It’s useful when entering a situation with multiple intended users, such as presenting to a board, approaching a partner, or engaging in discussions with a potential buyer.

Darren notes that both valuations should determine similar values for your business.

However, because a complete summary appraisal dives further into your financial and operational information, an appraiser may run across some details they wouldn’t otherwise notice while completing a more brief calculation of value.

For example, if any of that information affects your business’s risk (a key determinant of value), it could result in a different valuation than that of a calculation report.

Even so, while the level of detail differs between the two types of appraisals, the following process behind conducting them is virtually the same.

What’s Included in a Valuation

The first thing an appraiser will do is craft an engagement letter that outlines the purpose, scope of work and use of the valuation.

They’ll next begin a process of information gathering. This is the meat and potatoes of the valuation, where the appraiser collects all of your business’s data for analysis. Once the information is collected, they break it down into four categories:

* Financial analysis - This identifies trends based on your financial information, including the following: historical financial performance, adjusted income statements to determine adjusted cash flow, profitability and financial risk.

This information helps the appraiser determine how you stack up financially against your peers. More importantly, it determines your level of financial risk and cash flow, two of the key factors in deciding the value of your company.

* Operational analysis - This segment assesses risk based on the operational factors of your business. This includes the kind of market you serve, your business’s reliance on you (the owner), and the structure of your staff.

Combined, the operational analysis and the financial analysis are two of the most crucial components of any valuation, as they help determine the bulk of your business’s total risk.

* Market, industrial and economical analysis - This section focuses on economic and industrial trends relating to your business. To gather this information, appraisers must rely entirely on published sources of information, such as IBISworld.com. Unfortunately, this comes with a downside: data is limited and often between six months to a year old.

* Summary of valuation methods applied - This section simply summarizes the various methods used to conduct your valuation. The summary can be quite extensive, as is the case with a complete appraisal, or more brief, as it is with a calculation report. 

Although there are certain standards that every valuation must meet, there isn’t a specific formula that every appraiser uses to conduct a valuation. In this way, creating a valuation is something of an art: There’s a lot of subjectivity, and you’ll rarely get the exact same appraisal from two different appraisers.

For instance, one appraiser might determine that a company is more reliant on its owner, creating a higher amount of risk after you leave. However, a different appraiser might disagree, leading to a lower amount of determined risk and thus, a likely higher valuation.

If you’re thinking about selling your business, a valuation is absolutely vital. No matter which method you consider, understand the value of your company will provide the foundation for finding a synergistic buyer.

GCF Valuation, Inc. is now a valuable partner of the LaManna Alliance due to extensive collaboration and the ability to customize each assessment to our print-related clients. 

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Topics: Business Valuation