What Does Valuation of a Company Mean: Everything You Need to Know
What does valuation of a company mean? This is a common question amongst those wanting to sell their business. 4 min read
What Does Valuation of a Company Mean
What does valuation of a company mean? This is a common question amongst those wanting to sell their business. Such owners will need to determine the economic value of the company depending on varying factors. However, while most business owners are quick to assume that their business is worth a lot, an investor or potential buyer might have a very different opinion.
What Affects the Value of a Business?
There are a few things that can affect the value of a business; they include:
- Economic conditions
- How a business is sold
- Historical balance sheets
For example, if there are few jobs out there, more potential buyers will be interested in purchasing your business at a higher cost because they know they can easily hire employees.
How the business itself is sold is important. There is a significant difference between selling a business at an auction versus selling the business through marketing methods to attract several potential buyers.
Most importantly, your historical balance sheets significantly affect the value of your business. If your company has very little net profits, then your valuation will be low. If your debt exceeds your profits, then your business might have a zero dollar value.
Why is Business Valuation Important?
Valuing a business is not only important for a business owner wanting to sell the business, but it’s also important for other items, such as:
- Partial sale to another business
- Merger or acquisition
- Debt or equity financing
- The price of services or goods being sold by the business
- Establishing ownership in a partnership
- Divorce proceedings
The business owner might not want to sell the entire business to someone else; rather, he might want to sell off only a portion of the business. But even if only a portion is being sold, a potential buyer will need to know the valuation of the business as a whole.
Valuation is also important if companies are either merging or if one company is acquiring another business. For a merger, both businesses will need to be properly valued so the business owners are aware of the valuation of the other company. If, however, one business wants to acquire the other business, the acquiring company will want to know the valuation of the other company, particularly if that other company is struggling financially. Even so, there are many larger companies that acquire smaller, less financially stable companies with such knowledge; the goal there would be that the acquiring company knows that the valuation can be better with proper oversight and better marketing tools.
If you need debt or equity financing, then valuing your business is a must. Before you can obtain financing, any financial institution, investor, or venture capitalist will want to see the formal valuation of your business. They will not rely on the value you give them as they will want a proper valuation done by an independent business valuator.
If the business doesn’t have a high value, then the business can’t set incredibly high prices on its goods or services in an attempt to increase the value of the business. This will simply lead a potential consumer to go elsewhere, which could further hurt the business valuation.
Establishing ownership in a partnership is another important method where valuation comes in. For example, if you own a business with your partner, and you both want to properly value your business so you can determine how much ownership each of you have, and also identify who will be in charge of certain expenses, etc., properly valuing your business is crucial.
Divorce proceedings are another way in which valuation of your business is key. For example, assuming you are going through a divorce and your attorneys want to properly split assets, they will need to know the fair market value of your business in order to distribute assets to your partner. This is also important if the business itself is a partnership, since one of the partner’s could be affected by such a proceeding.
Who Can I Use to Value My Business?
Generally, business owners will hire a professional third party business valuator to give an objective valuation of the business. Whatever the reason for valuation might be, it is best to have an independent professional third party who can properly value your business. Moreover, using a third party professional will enhance your company’s credibility in that other businesses and investors will be more willing to look at your business more seriously to determine if they would be interested in purchasing it.
If you need help learning more about valuation of a business, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twilio.