There are many important reasons that business owners should know the value of their businesses. By understanding the financial health and accurate financial worth of your business, you will be able to successfully make impending business decisions based upon accurate knowledge.

However, popular myths about valuing a private business have held back some owners from getting a professional appraisal of their business’ worth. The following are the most popular myths:

1. Myth: Valuing a private business should only be done when the business is ready to be sold or a lender requires a valuation as part of its due diligence process.Fact: Getting a current business valuation will provide you with an accurate appraisal of the true worth of your business, as well as the financial health of your company. Having a business valuation gives you the ability to make informed decisions about the direction of your company, based on fact, not guess-work.

   With a current business valuation, you can buy, sell, or raise capital for your business, when the timing is right and with the confidence of having all the information at hand. Additionally, your company will be prepared for reorganization, Employee Stock Ownership Plans, estate planning, shareholder and partnership buyouts. Business valuations are also helpful in litigation, partner split-ups, business disputes, divorce, and tax challenges.

   If a company has several owners, a buy-sell agreement with accompanying life insurance should be in place so that if an owner dies, the remaining owners have sufficient funds to purchase the deceased owner’s interest at an agreed upon value. The buy-out value under these agreements should be updated regularly to reflect the company’s financial progress over time.
    

2. Myth: Businesses in my industry always sell for two-times annual revenue. So isn’t that what my business is worth?Fact: Revenue multiples used for selling purposes, are all over the chart. Rules-of-thumb used by business brokers to facilitate sales are median multiple values, that are used for convenience. Remember that the median value indicates that half of the revenue multiples are below the median value and half are above. The median value is a convenient midpoint and does not represent the accurate revenue multiple for a particular business, unless the business that is being valued is truly a median. What your company’s actual revenue multiple is can only be determined by a valuation approach that incorporates academically validated methods with industry-specific valuation factors.
    
3. Myth: A local competitor sold his business for three times revenue six months ago. Therefore, my business is worth at least this much.Fact: What happened six months ago is not really relevant to what something is worth today. What your business is worth today depends on three factors: how much cash it generates today; expected growth in cash in the foreseeable future; and the return that buyers require on their investment in your business.

   Unless your company’s cash flows and growth prospects are exactly the same as your competitor’s company, that company’s revenue multiple is irrelevant to valuing your company. Moreover, even if the competitor company was equivalent to yours in every respect, if interest rates were higher or lower today than six months ago when the competitor’s company sold, your company would sell for a different amount. Think of all the economic market conditions that have changed in the past six months. The value of your business is likely different today than six months ago because economic conditions have changed.
    

4. Myth: How much a business is worth depends on the purpose of the valuation. Depending on the situation, I may want business to be over-valued, or under-valued.
 

   Fact: According to the IRS, the Fair Market Value is what a buyer will pay a seller when each is fully informed and under no pressure to act. While there may be a FMV range, the wider the assigned valuation range is, the less reliable is the valuation and the more likely your company will face greater scrutiny from potential buyers and the IRS.

   The incentives to assign a low valuation when a parent sells a company to a child are significant. Given that the parent pays taxes on the difference between the value of the stock sold to the child and its value on the company’s books, establishing a low value on the company’s stock results in the parent minimizing the capital gains tax owed to the IRS. The child, on the other hand, has to come up with less money, because the sales price of the business is much lower than its FMV. On the other hand, a business may make a charitable contribution of company stock. In this case, there is a significant incentive to place the highest possible value on the donated shares, because this will result in the largest charitable tax deduction. However, in both these cases, having a professional business valuation, and utilizing its analysis will offset any IRS concerns.
    

5. Myth: If your business loses money, it is not worth much.Fact: Most private businesses appear to lose money. However, appearances are often misleading. Many businesses generate a great deal of cash, but the cash masquerades as legitimate expenses. For example, payments to officers can include the owner’s wage and a bonus the end of year. The wage is what the business would have to pay an employee to do the same job as the owner. This is a real expense. However, the bonus represents a return to capital. It is the cash the business generated and it is this cash that determines the value of the business. Quantifying the size of these discretionary expenses is often a critical determinant of the company’s value. A professional business valuation will point out these discretionary expenditures and include them as value to the business.

 From the above facts, you can understand the many reasons that a current business valuation is critical for your company. A note of caution: make sure that the professional that is valuating your business has years of experience and is accredited, in order to receive an accurate portrayal of your business.

Mr. Al Golden specializes in providing CFO and Controller Services, forensic accounting, comprehensive business valuation, and forensic accounting. He is a Certified Public Accountant (CPA), Certified Valuation Analyst (CVA), a Diplomat of the American Board of Forensic Accounting (DABFA), Certified in Financial Forensics (CFF), and is a member of the American Institute of Certified Public Accountants, the National Association of Certified Valuation Analysts, and the American College of Forensic Examiners.

A.M. Golden Accountancy Corporation offers a free initial consultation - To speak with Mr. Golden immediately, please call his direct line by dialing (760) 444-1913.  If you’d prefer, you may also send an email: al@amgolden.com