How to estimate the value of a business

Estimating the value of a business is not a simple task. The topic of business evaluation is so complex that it could fill a whole book on its own. It can also be said that it is an art, not a science. The first thing to understand is that there is a difference between value and price. The valuation of a business makes certain assumptions and is established at an historical point in time. The price is a function of the value, the perception of the future, the terms and conditions of the deal and other factors. The value of a business can vary weekly, depending on several factors such as interest rates, the strength of the economy and the availability of capital. The complexity is further compounded by the fact that business owners purposes, motives and goals in valuing their businesses can vary greatly. The process has to take in to account numerous variables and requires that a number of assumptions be made. Six of the most important factors that determine fair market value are:

  • Recent profit history.
  • General condition of the company (for example, condition of facilities and equipment, completeness and accuracy of books and records, employee morale and state of inventory);
  • Market demand for the particular type of business;
  • Economic conditions – especially cost and availability of capital and any economic factors that directly affect the business;
  • Ability to transfer goodwill or other intangible values to a new owner; and
  • Future profit potential.

However there is really no such thing as fair market value as three other factors often influence the agreed upon price.

  • Special circumstances of the particular buyer and seller;
  • trade offs between cash and terms; and
  • relative tax consequences for the buyer and the seller which depend on how the transaction is structured.