When preparing your plan for passing on your business to family, it's important to have it properly valued. Failure to calculate the actual value of the company you've grown could result in problems between heirs and family members, loss of some of that value if it's sold, and undervaluing things like insurance and other protections for your inheritors.
To understand what valuation really entails, here are the basics of the three methods to do it.
Assets Based Approach
Perhaps the easiest way to know what your business is actually worth right now is to add its assets and subtract the liabilities. You can either value these items based on your current balance sheet values or on what you could get for them if you liquidated everything in a fire sale tomorrow. Asset based valuation works best, obviously, in a company that's kept nicely separated from the owner's personal assets and that features hard goods being sold. Assets are usually tangible goods, so intangible things (like customer bases, goodwill, or reputation) may not be fully included.
Earnings Based Approach
If you have a service or trade business, you may do better to opt for an earnings based valuation. This type of methodology looks at your business' earnings in years past and projects them forward (while accounting for outliers), but multiplied by a rate of return for a new owner. The fundamental idea behind this strategy is that a business' real value lies in what it produces in income for the future.
Market Value Approach
This type of valuation looks at similar businesses in your market to determine how much your company is worth. This is often an approach that owners take when attempting to value their own business themselves. It can work well, since it reflects the real price you can get for your labors right now, but it may be limited in usefulness if there aren't a lot of other business to compare.
You may be able to create a "ball park" valuation on your own using any of these three ideas, but it's best to hire a professional business valuation service to do the real numbers. They will likely use a combination of these methods to achieve the most accurate total.
And--while it all may be a bit confusing to a business owner--the more accurate your valuation, they more likely it will be to help you design the best continuity plan.
