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Discover the essentials of business appraisal, a formal process to determine a company's worth, crucial for selling, securing loans, or legal matters. Learn the differences between appraisal and valuation, and explore the methods used by certified professionals to assess your business's value.
A business appraisal is a formal process to determine a company's worth. It is commonly the first step of a business sale, as owners want to know how much they can ask for their venture to get a fair deal.
Appraisals can also be necessary in other business, litigation, or financial scenarios.
In this article, you'll learn what a business appraisal is, the difference between a valuation, and why it matters in a sale.
While the terms "business appraisal" and "business valuation" are often used interchangeably, there's a slight difference between the two. A business appraisal typically focuses on the value of a company’s tangible assets and must be conducted by a certified appraiser.
During the process, the certified appraiser employs several valuation methods to determine your company's value. The appraisal includes analyzing financial statements and applying the income, asset, and market approaches to reach a comprehensive valuation.
Business appraisals can have several purposes aside from selling a business, like resolving a legal dispute, planning a succession, securing a loan, or evaluating a potential investment.
In contrast, a business valuation provides a holistic assessment of a company’s total value, encompassing both tangible and intangible assets.
A business appraisal provides an accurate assessment of the value of your business assets through the evaluation by a certified third party. As a business owner, you’ll gain a clearer understanding of your company's worth.
Knowing how much your business is worth is important to initiate any sales process through an M&A transaction because it enables you to set a realistic asking price and provides a basis for making improvements to enhance your company's value.
Additionally, potential buyers may request a business appraisal from a third party before proceeding with the purchase.
Another benefit of a business appraisal is that it can attract potential investors by demonstrating the value and stability of your business.
Business appraisals are used in these scenarios:
When preparing for a sale, entrepreneurs must determine an appropriate asking price. On the other hand, a prospective buyer makes sure they're paying a fair market value for the business.
Here are some other use-cases of business appraisals:
Ventures involved in legal matters such as lawsuits, marital dissolution, and shareholder disputes may be required to get a business valuation by court order. This valuation provides an objective basis for resolving financial disputes and ensuring fair settlements.
The IRS may require business owners to provide a certified business valuation if the company is being donated or bequeathed. This valuation helps determine the appropriate tax implications associated with the donation or bequest, ensuring compliance with tax regulations.
Lenders often request a certified business valuation before approving a loan. This is particularly common with traditional lenders such as commercial banks or credit unions and for most SBA loans. The valuation helps lenders assess the business’s financial health and viability as part of their risk assessment.
Organizations planning to go public through an Initial Public Offering (IPO) must conduct a business valuation. In this scenario, investment bankers and underwriters typically oversee the process to establish the company's market value.
When doing a business appraisal, certified professionals can use three different methods or approaches:
Also known as the cost approach, this business appraisal method estimates the total value of the business assets listed in the balance sheet. Once the total asset value is determined, the certified appraiser subtracts the business liabilities listed in the balance sheet, to calculate the company's total present equity.
Within the asset approach, appraisers can choose between the book value approach and the adjusted net asset approach:
The Asset Method is most commonly applied to underperforming companies or those with significant tangible assets. However, it’s less effective for businesses with substantial profits or valuable intangible assets, such as intellectual property or brand equity.
The income approach, also known as the income capitalization method, focuses on the business's potential to generate future earnings. Appraisers evaluate the costs and benefits associated with the business, considering factors such as profits, revenue growth, and the potential for increased value. On the cost side, they account for operating capital requirements, ownership risk, and liabilities.
The income approach can also be explained as weighing the expected benefits of investing in the company against any potential risk. This method also considers any possible change in working capital and capital expenditures.
This approach is considered the most subjective method. It can be compared to how mortgage companies conduct a home appraisal.
Through this method, the appraiser establishes the business value by comparing the sale price to similar businesses within the same industry and market. Appraisers analyze comparable businesses' financial performance and sales prices to arrive at a fair market value for the company.
The Market Value Method is particularly useful when there is sufficient data on comparable business sales, though it can be challenging to apply in unique industries or for businesses with few direct competitors.
Certified appraisers must follow the Uniform Standards of Professional Appraisal Practice (USPAP), the authoritative source of appraisal standards in North America. Following USPAP ensures that appraisers conduct their work professionally, consistently, and reliably.
Appraisers must also follow guidelines established by professional organizations, such as the Institute of Business Appraisers (IBA) and the American Society of Appraisers (ASA).
If you are planning on selling your business, Boopos can help you evaluate your company's worth to get a fair price.
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