Definition and Meaning of a Business Valuation
One of the principal tasks a small business owner must complete often and accurately is business valuation. Yet, for many small business owners, “business valuation” is a loaded phrase, and one to avoid. Frequently, however, this aversion to business valuation is a result of a fundamental misunderstanding. (Keep reading to understand the Definition and Meaning of a Business Valuation)
That said, this misunderstanding is easy to clear up.
Why do Small Businesses Avoid Valuation?
Before understanding the definition and meaning of a business valuation and it´s importance, it’s essential first to understand why business owners shy away from the process and provide a counter. We typically see four common mentalities interwoven in varying degrees among business owners:
Successful business owners are, given the nature of success, very busy. They wear many hats and must learn the day-to-day details of tasks not associated with their core business mission, such as bookkeeping, state and local law compliance, payroll management, etc.
These, and other tasks peripheral to running a successful business, are relatively low-density; they are skills that can be developed quickly or outsourced locally. But many see business valuation as a financial engineering tool beyond their scope.
And, with that complexity anchored in their mind, they (rightly) see themselves as too busy to learn a skill as complex as business valuation.
But sticking your head in the sand is rarely a good option—especially when it has such an impact on your immediate and long-term future wealth, as well as the prosperity of the business itself that you’re putting everything into.
Some business owners assume that external sourcing through pricy consulting services is mandatory—regardless of size, scope, or complexity. But this isn’t necessarily the case.
Will getting a business valuation from an unqualified source render it worthless? Most likely. But many expert, experienced, and trustworthy business valuation firms focus exclusively on valuing businesses like yours. And, since business valuation is the core of their business, they are typically quick, efficient, accurate, and far more cost-effective than you think.
For those seeking speed or a more hands-off approach, the advent of global interconnectivity is your savior. Since much of the task involves interpreting and analyzing data from well-documented financials, and management interviews that can now be done via video calls, they may not even need to visit you physically. Your fears of high-priced Big 4 consultants coming in and expensing weeks’ worth of work are off base.
“I’m not selling my business.” This is a common reaction for many business owners when confronted with the prospect of business valuation. “Why place a price tag on it today when I won’t sell until I’m ready to retire?”
However, this mentality is erroneous. Having a constant valuation metric handy is critical for business owners for nearly infinite reasons. The most basic and valuable driver of recurring business valuation is that the process shows you, as an owner, the trajectory of your business’ growth over time.
Whether it’s flat, moving upward, or spiking down, plotting your valuation over time gives owners critical insights into the performance and success of a business. And, in many cases, a poor trajectory can unveil hidden costs, elevated risks, or poor-performing aspects of a company that wouldn’t be evident otherwise.
Sentimentality towards value is emotionally charged. High-sentimental value is understandable; many put tons of sweat equity into their venture, and businesses are often a family affair that imbues an additional level of personal goodwill into the company.
While intangible assets are often a core part of businesses, neither sweat equity nor personal attachment are on the balance sheet. Formal business valuation, therefore, feels like it’s cheapening the company to those who are particularly invested in the end number as an all-encompassing arbiter of self-worth.
It doesn’t need to be this way. As this is an emotional appeal, the counter is likewise emotional. No matter the end number, your legacy and effort don’t hinge on a number your appraiser finds. Instead, measure your sentimental value—hard work, relationships built, communities impacted—alongside a clinical business valuation and treasure that result independent of financial valuation.
Defining Business Valuation
We’ve knocked down some commonly held beliefs that scare business owners away from a business valuation. In doing so, we’ve hinted around the edges of what business valuation truly is. But, while business owners might have different perspectives on a definition depending on the degree to which each of the four mental models applies, business valuation nevertheless has a central and immutable definition.
Definition And Meaning Of A Business Valuation – Definition
Business valuation is the process of identifying the present worth of a business or asset. In other words, it’s the economic or financial measurement of an owner’s stake in their business. Clinical and somewhat obtuse, maybe, but this is the fundamental definition of business valuation.
Definition And Meaning Of A Business Valuation – Meaning
But what does that mean? It’s helpful to think of the business valuation from the context of another metric: share price or market capitalization. Public companies’ stock price (the business’ value on a per common share basis) comes from the expected future value of cash flows, growth prospects, macroeconomic and industry conditions, and many other variables collaboratively managed by the equity market members.
Business valuation measures the value of the business today. If you put a privately held business on the market and have an agreeable buyer immediately, the business valuation would be the expected exchange price, ONLY providing that both parties made their purchase decision after analyzing all the information.
In both cases, the process of valuing the business means that the analyst or buyer has incorporated or processed all the quantitative and qualitative data and identified a value.
A successful business valuation means two things, to be:
- Accurate: if it’s not accurate, you may sell your business for significantly less than its value, or overpay on a purchase, or be subject to improper taxation
- Justification: if presenting the business valuation to the IRS for tax compliance or in litigation for disputes, it must be extremely defensible
In both cases (definition and meaning of a business valuation), this is where a quality appraiser is well worth the investment.