How to Determine Small Business Valuation?

Small business valuation is simply the amount that a prospective buyer would pay for it or market value. Unlike a corporation, a sole partnership or even a limited liability business with limited partners, a business that is run by the owner can't present what's commonly termed a full-on financial statement of its entirety. This makes it more difficult to assess whether the sale price is indeed fair and appropriate for the property being offered. Fortunately, there are several steps that an owner can take to better understand the worth of their own company.

For most small businesses, the first step to understanding the market value of your company is to contact a competent broker or appraiser. Appraisals typically include looking at several different factors, including the location and nature of the business itself. As you'll likely have no direct experience in these matters, it's best to leave the task to someone who can offer impartial guidance based on your company's specific situation. Many brokers and appraisers charge fees for this service, so it's important to shop around before hiring.

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If you're not ready to hire an independent appraiser, you may still be able to use one or two small business valuation calculators. These aren't as accurate, but they're usually free or come highly recommended from knowledgeable sources. Small businesses may also be able to use online calculators or websites that provide simple data collection methods. The only problem with these is that they don't allow you to run multiple searches on the same data, so you need to either manually search through dozens of companies or allow the program to search multiple databases for your business's information.

Regardless, of which method a buyer chooses, the first step in understanding the market value of a given business is to decide how much you want to spend on it. Keep in mind that the buyer doesn't have to buy at all if there is no realistic chance that they will be able to do so. Likewise, if a buyer can't afford to buy, they shouldn't go ahead with the purchase. Use the following buyer's finance tips to help you choose a reasonable purchase price.

Assess cash flows by evaluating past five years of income and expenses. If the business has been stable, consider its credit ratings and compare them to the investment in the listing to determine if its creditworthiness is improving. For the most part, real estate appraisals are done by private firms, so it's likely that one of them will be able to give you an accurate valuation based on recent sales data.

Investors are encouraged to avoid the market-based valuation of small businesses because they don't offer a diversified portfolio. Instead, focus on looking at the intrinsic value of your listed asset or business. This form of valuation uses current market data to estimate future value. In other words, it does not take into account potential appreciation. Market-based valuation has several disadvantages, however. First, the true market price of your property may be higher than what you initially paid for it because the price may have already been affected by the economy or other economic factors.

Business liquidation is another method used for valuation, but it's not utilized as often as other methods because it takes more time and costs more money. Small businesses usually go through liquidation when the owner decides to sell, retire or exercise options. To determine the value of a company's assets, liquidation experts use a standard set of economic assumptions. While these assumptions are typically updated every five years, they are based on previous years' data and can actually undervalue the value of the company's assets. Business liquidation also doesn't account for any potential benefit that could arise from expansion, whether through renovation or reorganization.

Because the numbers can fluctuate drastically from year to year, companies that are often on the verge of bankruptcy use an alternative method called the adjusted net asset method (ANAT). This method takes into account only those assets that have increased in value over the last five years and apply it to the current year and industry. Because the discounted value of the assets does not include any possible future impairment of value due to events outside of a company's control, this valuation method tends to undervalue the real value of a company's assets. Businesses should choose which valuation method is best for them.