When preparing for business succession, the question of business value inevitably arises sooner or later. Business value is essential, for example, for determining the share of the business in the estate, for tax calculations, and for preparing to sell the business. This article highlights five key benefits of a well-prepared business valuation.
1. The company’s value is not the same as the purchase price.
What is your business worth? Few business owners can answer this with a specific figure, which usually corresponds to their expected selling price. Most—often seasoned business owners—become uncertain when answering this question. In our daily consulting practice, we often hear: “The sum of all assets plus amount X.”
Generally speaking, for most company buyers, the value of a company is determined solely by its future, transferable earnings value. The purchase price itself rarely represents the company’s true value; rather, it reflects the amount a buyer is willing to pay at the moment of ownership transfer.
2. The Multiplier Approach Complements the Income Approach
Surprisingly often, family-run small and medium-sized businesses rely on so-called multiples when determining a company’s value. In this approach, the company’s value is derived from prices paid in transactions involving comparable companies in the same industry with revenue of 50 million euros or more. This method thus assumes that conclusions about the value of the company in question can be drawn from the observable market prices of comparable companies.
This valuation method is helpful for an initial assessment but is not comparable to a customized business valuation: This is because the multiplier approach is often used to value significantly larger and more transparent companies and generally does not take into account changes in the business environment, special or one-time effects, or market expectations that influence enterprise value.
The multiplier approach is therefore more of a supplementary method for obtaining indications of a company’s value or for validating company valuations based on income-oriented methods.
3. A good business valuation answers buyers’ questions in advance
A well-prepared business valuation, on the other hand, strengthens the business owner’s negotiating position and answers potential questions from prospective buyers in advance. This ensures that a seller knows the current earnings-based value of their company and the key current factors influencing the company’s development in detail, and is thus ideally prepared for negotiations. At the same time, it lays a solid foundation for the acquirer’s subsequent due diligence or financing discussions.
In practice, two methods for determining a company’s value have become established: the income approach in accordance with the IDW S 1 standard and the discounted cash flow (DCF) method. The income approach is used particularly in German-speaking countries and, like the DCF method, is accepted by the authorities. The DCF method, on the other hand, is an internationally accepted standard.
4. Realistic future projections provide supporting arguments
Both methods share the principle that, when determining a company’s value, the results of the past three years are adjusted for one-time and extraordinary effects as well as tax-saving models, and then supplemented with a future projection that is as plausible as possible. Valuation specialist Ralf Harrie points out that the future forecast, in particular, should be conservative: “Sharply rising revenues or rapidly falling costs must be justified in a comprehensible manner.”
He further adds that the results depend not least on an assessment of the company’s future earnings that is as objective as possible and on a realistic risk assessment: “For the majority of family-owned businesses, a customized risk assessment is recommended rather than applying the lower risk multipliers used for publicly traded companies.”
5. A Well-Founded Business Valuation Reduces the Financial Burden on Successors
As part of a business valuation, the business owner is, in effect, compelled to engage very intensively with the future development of their company. When preparing a business valuation, it is advisable to consult specialized advisors. By critically reviewing the information provided, these external specialists ensure that a market-based purchase price expectation can be derived from the business valuation. At the same time, a well-founded business valuation allows for optimal preparation for the sale of the company.
Furthermore, the tax authorities generally accept a conclusive valuation report as an alternative to the procedure defined in Section 199 of the Valuation Act (BewG). Consequently, this often results in a lower tax burden or lower settlement amounts owed to co-heirs, and thus a reduced financial burden on the businesses being transferred.
Further information on business valuation
