Business Valuations may be required for a variety of purposes in addition to the most obvious one, when the business is to be sold. Formal valuations are sometimes required for divorce and separation proceedings, inheritance tax calculations, business disputes and for many other reasons.
For owners who wish to sell their business, they must beware of business brokers who will persuade owners to sign up with them by producing an unrealistic valuation for their business. Setting the Guide Price for the business too high is a common and costly mistake - it will put buyers off and once buyers have been put off, they are usually lost forever.
The valuation of a private company is a combination of �science and art� and it needs to be carried out by somebody who is not only capable of understanding, often complex, financial statements but also who understands the business sale process and the market. Therefore, a business broker is in the best position to carry out this work, but only if he can exercise the necessary technical knowledge together with his market experience.
The valuation of private businesses is, at core, based on the sustainable cash flow which the business can reasonably be expected to produce over future years. Buyers, in simple terms, measure the time it will take to recover the cash investment they make. They are usually looking to do this in a period of no more than from 3 to 5 years. The top of this range may be breached for smaller, life-style businesses, where buyers may place more value on the ability of the business to provide them with a secure job, unfettered by corporate concerns.
The valuation calculation tends to be simplified to using a multiple of the historic and current Operating Profit (usually Profit before Interest and Tax) adjusted for non-recurring and unusual expenses. For instance, adjustments are often required to reflect the cost of replacing the owner�s labour because, for tax reasons, the owner may receive little remuneration through PAYE and more through dividend, consequently increasing the Operating Profit figure.
Depending on the nature of the sale (usually shares or assets) the valuation will need to take into account balance sheet figures such as external debt, working capital balances and assets such as equipment and property. Freehold or long-leasehold property should always be valued and sold separately.
In addition, other, less tangible factors need to be considered such as the sustainability of earnings, the overall risk and attractiveness of the sector, the prospects for growth and the disruption likely as a result of the change of business ownership.
In the case of a sale, in the end the business is worth what a buyer will pay. A good business broker will try to create a competitive bidding situation among a short list of purchasers in order to achieve the best deal for the owner.