One of the most difficult aspects of buying or selling a business is determining its value. One might say that, as with so many things in our society, a business is only worth whatever someone is willing to pay for it.
However, it’s essential to get a professional valuation of the business so that the buyer and seller know a baseline for their price negotiations.
There are three main approaches for business valuation: the market-based approach, the asset-based approach and the income-based approach.
The market-based approach is based on recent sales of similar businesses. It is somewhat similar to home valuation in that it requires looking at properties with similar attributes in a similar geographical area or market niche and calculating something like an average price. Of course, home valuation is not an exact science, because every home and location has its own advantages, disadvantages and distinct features. Likewise, no two small businesses are exactly alike.
The asset-based approach breaks down the tangible assets of the business and calculates their fair market value. This method can be good in some situations, but its major drawback is its failure to measure intangible assets, such as market goodwill. For instance, a good community reputation is a valuable asset for a small retail store, because it attracts loyal customers. This value doesn’t necessarily show up in an asset-based valuation.
An income-based approach looks at the past income of the business, forecasts of future income and debt, in order to determine value. Like the other approaches, this approach has advantages and disadvantages.
A skilled lawyer can help business owners and buyers to use a multi-pronged approach so that they can get a more complete picture of the value of the property and make better decisions.