How Is the Value of a Business Determined?

How much a business is worth is critical for several reasons. Anyone wishing to buy or sell a business needs to understand its value. The value of business is instrumental not just when buying or selling it, or a part of it, but also in obtaining loans, expanding the business, merging the business with another venture, for tax purposes, or for other reasons.

The main factors in valuing a business

The starting point for the value of a business is usually defined as the amount a willing, voluntary buyer would pay to a willing, voluntary seller. Buyers need to conduct due diligence to determine the value of what they are buying. This typically means working with an experienced law firm and an experienced financial professional.

The buyer (or his or her financial expert) needs to be able to examine tax returns, profit and loss statements, balance sheets, credit reports, statements, account payables and receivables, inventory, and other documents. The buyer needs to understand what actual or contingent liabilities the company may have. Buyers need physically to review the property, equipment, inventory, and other assets of the company.

Sellers need to work with their accountants and their lawyer to fully review the assets, liabilities, and other factors that determine value.

Experienced Tennessee lawyers will review many factors such as:

• The type of business. If the business is a professional service, such as an accounting firm, a medical office, a law office, or an IT firm, then the value of the business is often tied in to how successful the professional is at his/her job. Still, many other professionals are willing to pay good money for client and customer lists, office equipment, and the right to speak to the staff about working with the buyer.

If the owner only has stock in the company, then the value of the business interest depends on the value of the stock. If the owner has stock and also runs the company, then other factors are used to value the business.

• The business structure. The value differs depending on whether the business is a corporation, a partnership, or a sole proprietorship. Sole proprietors and partners usually derive an income from the company. When they sell their ownership interest, they still may wish to have an ability to work for the company. In some cases, such as partnership agreements, the other partners may have the right to buy the company before outsiders can.
• The valuation method. There are three basic ways to determine a business’s worth:
  • The asset approach. This method examines the financial assets of the business and the book value of any stock interests. Assets include much more than just tangible items and stocks. They also include good will, intellectual property, trade secrets, and customer/client/vendor information.
  • The income approach. This method examines how much income the business provides the business owner on a yearly basis. Buyers usually pay a multiple of the yearly income figure.
  • The market approach. This approach compares the business to similar businesses in the same area and examines how much those businesses have sold for in the past.

Valuing a company is often both art and a science. Skilled Nashville business lawyers focus on understanding the reasons for buying and selling a company before they work on determining the value. They may review the different ways of determining value first – and then argue one method or blend of methods is more appropriate than another. At the Law Office of Perry A. Craft, PLLC, we have the experience and resources to guide you through the business valuation process. To speak with a respected business lawyer in Nashville, call us at 615-953-3808 or complete our contact form to arrange a consultation.