Business owners may need to conduct a thorough financial evaluation of their business for a wide range of reasons, such as preparing for a merger, tax reasons, or even a divorce. Business valuations analyze the business and assign an economic value to it based on numerous factors. There are several common business valuation methods to choose from, and the right choice will vary depending on the reason for the valuation and the company. Both large companies and small businesses use evaluations according to the Small Business Administration. At the Ferlito Law Group, our New York State business lawyers assist business owners with valuations and other legal matters related to running a business: call us today to learn more about determining the value of your business.
When Is a Business Valuation Necessary?
The business valuation process is complicated and involves a thorough analysis of the entire business, including anything with a financial value. Business valuations are necessary in a wide range of common circumstances, such as:
- Selling a business
- Changes in ownership
- Conducting a merger
- Acquiring another business
- During the search for investors or financing
- Assigning percentages in a partner business structure
- Adding new shareholders
- Tax requirements of the Internal Revenue Service
- Estate planning
Due to the complicated nature of this process and the importance of making sure it is done right, many business owners turn to professionals for assistance with their business valuations. CPAs and business valuation lawyers can both provide useful guidance throughout the process.
The Most Common Types of Business Valuation Methods
Every business is unique, so the appropriate business valuation method will depend on the needs of that business, the purpose of the valuation, the financial situation of the business and its owner, and numerous other variables. A business valuation professional can help choose the right option and conduct the full valuation on the owner’s behalf.
The asset-based business valuation method is one of the simpler options and is most used to determine the minimum value of the business. This method is based on adding up all the company’s assets and subtracting liabilities to determine its value. Assets include anything with a tangible or intangible value, such as cash, inventory, real estate, equipment, stocks, intellectual property rights, the customer base, and anything else with economic value.
There are two main types of asset-based valuations: “going concern” and liquidation value. If the business plans to continue operating (and not sell any assets) it will likely choose the going-concern method. This is the simple valuation method described above – nothing more than subtracting liabilities from assets. The liquidation-based approach assumes that the business is done operating and will liquidate its assets. This approach values the assets based on the net cash that the owner would receive if the assets were sold.
ROI-based business valuations determine the value of a business based on its profit and an estimate of a return on investment (ROI) an investor could realistically expect to receive for injecting funds into the business. This method is most used when a business is seeking capital. This method is considerably more complicated than an asset-based valuation, as the ROI can vary depending on the current state of the market.
Investors will likely have several questions related to ROI, including:
- The amount of time before they can expect to recover the original investment
- What will their share of the expected net income be?
- How was the ROI calculated and how conservative is the estimate?
The business lawyers of Ferlito Law Group help their clients with ROI-based approaches and all other types of business valuation methods.
Market Capitalization Method
Market capitalization is a business valuation method available to companies with stockholders. This is the simplest type of business valuation, as it is calculated by multiplying the share price of the company by its total number of outstanding shares. For example, a company with 1 million shares selling for $10 would be valued at $10 million.
Times Revenue Business Valuations
While the asset-based method is designed to calculate the floor of the business’s value, times revenue is used to assign a maximum value. The times revenue business valuation method analyzes revenue sources based on industry-specific and environmental variables. The value of the current revenues is multiplied based on the industry and the local business and economic environment to determine the ceiling for the business. This multiple may be up to two times the actual revenues for some businesses, but those in other industries may have a multiple that is less than one.
Valuing a Company Using the Earnings Multiplier
The earnings multiplier is used to determine the real value of a business. This calculation estimates a company’s current stock price based on the company’s earnings per share (EPS) of stock. Companies with stocks use this method to compare the relative price of their stocks with similar companies. The earnings multiplier is often used for financing, as investors can use this formula to evaluate current stock prices compared to historical prices.
How Can a Business Valuation Lawyer Help?
The professional services of an experienced business valuation lawyer can be useful in several different ways, including:
- Gathering the right documentation
- Developing financial estimates for ROI-based and other types of valuations
- Assisting with a business valuation in a divorce case
- Estate planning concerns, including the estate tax
- Post-acquisition disputes
These are just a few of the most common examples of business valuation legal services, but our experienced attorneys are prepared to help business owners with the full range of business valuation matters.
Contact Our New York Business Valuation Lawyers
Business owners should consider conducting a business valuation when making major changes in the company, such as a sale, merger, acquisition, or adding stockholders. Business valuation involves a host of intricate legal and financial complexities that must be considered to arrive at an accurate valuation of the company. At the Ferlito Law Group, our team of veteran New York business lawyers specializes in business valuation and other legal concerns related to business ownership. We are prepared to stand by your business throughout the valuation process, from choosing the right valuation method to completing the valuation. Contact us today to learn more about business valuation methods and other business matters.