The business valuation profession has undergone a large transformation since the 1980s, developing from a rudimentary process into a highly sophisticated mix of art and science. Even so, many small business owners and investors fail to understand the valuation process and its results. Here are some common business valuation myths and the underlying truths.
Myth:When a business interest is sold, the seller will receive the amount that the business was given as fair market value during the appraisal.
Truth: Fair market value is different from a transactional value, in that FMV is hypothetical, and should be looked at as a most likely value given the hypothetical considerations. A transaction value, on the other hand, is a price at which the business actually changes. Transactional value may be significantly different than fair market value, depending on the circumstances.
Myth: A business owner has the best knowledge of what their company is worth.
Truth: Knowledge of the inner workings of a business is not enough to qualify the owner to value the business. Valuation is a profession with accreditations, standards, and professionals with tremendous experience. The valuation professional also is an objective third-party. Business owners tend to view their businesses differently than outsiders, and need to understand how outsiders view the business, because it’s hypothetical investors that determine FMV.
Myth: If a business is worth $1 million, a 10 percent interest should be worth $100,000.
Truth: Owning a minority interest in a business diminishes the interest’s value from the value of the entire business. A minority interest cannot determine policy, set compensation for officers and other owners, or decide whether to sell the business. There are many other items that cannot be controlled by a minority owner.
Myth: The owner’s contributions to a business enhance the value of the business.
Truth: This is often true, but there’s a major exception. Owners may possess talents, relationships or other intangible assets that cannot be transferred to buyers. Owners who contribute personal goodwill diminish the value of the business to an unrelated party.
Myth: A valuation report can be used for multiple purposes, such as using a report that is prepared for estate planning purposes to get a loan, or settle a divorce.
Truth: A business valuation is prepared for a specific business as of a specific date and for a specific purpose. If any of these things change, the valuation is no longer valid. Different purposes for a valuation might require a different standard or basis of value. It’s important that the user of a valuation report understand its use is intended for.
To attain a better understanding of business valuation, owners and investors should discuss the valuation process and various options with Filler & Associates.