When it comes to selling or buying a closely held company, business valuation is an important issue. For sellers, the concern should be to ensure that one is able to receive a return on one’s investment, if possible. And buyers, of course, usually want to get a deal. Business valuation would be easier if it could be determined by a set formula, but as a recent article in The Lane Report notes, there is both a science and an art to business valuation.  

One of the problems is that business owners often believe their company is worth more than it actually is. This is particularly the case when the economy is on an upswing. Another problem, at least for closely held companies, is that obtaining the market information necessary to make a good valuation can be a challenge. Yet another problem is that there are different ways to approach business valuation, and depending on which approach you use, the valuation of a business can vary significantly. 

One approach to valuation is to look at a company’s assets and base the value of the company on that. This approach can be particularly useful for businesses which depend on these assets for its income. To the extent this is not the case, it can be helpful to look at valuation from another perspective.

Looking at the company’s income is another approach. The idea here is looking at the company’s recorded earnings and projecting future earnings based on tax returns and other records. When these records are not accurate, not surprisingly, this can be a challenge. When records are thorough and accurate, this can be an effective approach.

In our next post, we’ll continue looking at this topic.

Source: The Lane Report, “Business valuation is science and art,” Greg Peath, October 16, 2014.