Why do most business owners want to know about the value of their business?  This question is not intended to be flip, but it is one that  needs to be answered.  Of course, there is the curiosity factor, but there is usually something behind that wanting-to-know. Does an owner need to know for estate purposes?  Does the bank want to know for lending purposes?  Is the owner entertaining bringing in a partner or partners?  Is he or she thinking of selling?  Is a divorce or partnership dispute occurring?  Is it for a buy-sell agreement?  There are many reasons why knowing the value of the business is important.

The reason for the valuation is critical. For example, in a divorce or partnership breakup, each side has a vested interest in the value of the business. If the husband is the owner, he wants as low a value as possible, while his spouse wants the highest value.  The departing partner wants as high a price as possible.  If an owner is selling half of his business to a partner, he or she would want as a high a value as possible.  In the case of a business loan, a lender values the business based on what he could sell and thus recapture the amount of the loan.  This may be just the amount of the hard assets, namely fixtures and equipment, receivables, real estate, or other similar assets.

In almost all cases, with the possible exception of the loan value, the applicable value definition would be Fair Market Value.  It is normally defined as: “The price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”  This definition is used by most courts. 

It is interesting that the most common definition of value begins with the phrase “The price…”  Most business owners, when using the term “value,” really mean price. “How much can I get for it if I decide to sell?”  If there are legal issues, a valuation is most likely needed.  In most cases, however, what the owner is looking for is a price.  Unfortunately, until the business sells there really isn’t a price.

The International Business Brokers Association (IBBA) defines price as “The total of all consideration passed at any time between the buyer and the seller for an ownership interest in a business enterprise which may include, but is not limited to, all remuneration for tangible and intangible assets such as furniture, equipment, supplies, inventory, working capital, non-competition agreements, employment and/or consultation agreements, licenses, customer lists, franchise fees, assumed liabilities, stock options or stock redemptions, real estate, leases, royalties, earn-outs, and future considerations.”

In short, value is something that may have to be defended, and on which not everyone may agree.   Price is very simple – it is what something is sold for.  It may have been negotiated; it may be the seller’s or buyer’s perception of value and one in which their perceptions coincided (at least, once, to allow a closing to take place), or a court may have decided. 

The moral here is for a business owner to be careful what he or she asks for.  Do you need a valuation or do you just want to know what someone thinks your business will sell for?

Business brokers can be a big help in establishing value or price!

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