When it comes time to sell your business, there are all sorts of factors to consider, including the value of your business.
For many business owners, the concepts of valuation vs. appraisal are often seen as interchangeable. But they’re not.
Whether you’re seeking to maximize your return on investment or simply want to understand your potential sale price, it’s worth taking the time to understand the differences.
Let’s dive in.
What’s a Business Valuation?
A business valuation is the process of determining what a business is currently worth. This is an estimate of what a potential buyer would pay for your business if it were for sale on the open market.
Types of Valuation Methods
There are three main methods of business valuations:
- Income Approach
- Market Approach
- Asset Approach
The income valuation method looks at the business’s future earning potential and the present value of that income.
The market valuation method looks at the comparable sales value of similar businesses that have been sold recently, while the asset approach considers the value of the business’s physical assets.
Here are a handful of examples of what’s looked at in the valuation process:
- Assets: What assets does the company own? This includes physical assets such as property, plants and equipment, intangible assets (i.e. patents and copyrights), and financial assets (i.e. investments and cash).
- Liabilities: What liabilities does the company have? This includes debt obligations such as term loans, accounts payable, and accrued expenses.
- Earnings History: What has the company’s earnings history been? Valuations often use adjusted historical earnings to get an understanding of how much the business can earn in the future.
- Future Expectations: What are the company’s future expectations? Valuations may use expected growth rate or revenues to determine potential worth of a business.
- Economic Conditions: What is the current state of the economy? Factors such as inflation rate and GDP growth are typically considered when assessing fair value for a business.
A business valuation report is typically prepared by a professional valuator and can be used to help business owners make informed decisions.
What’s a Business Appraisal?
While business valuations are designed to determine the overall value of a business, a business appraisal is designed to determine the value of specific assets within the business. Typically appraisals are done for the purpose of securing a loan or settling an estate.
For example, you might need to determine the value of your company’s machinery, intellectual property/intangible assets, or real estate.
Appraisals are typically used when there is a specific reason to determine the value of a specific asset, such as when you’re considering selling the asset separately from the business.
A business appraisal may be used as an informal pricing guide, but a true business valuation is usually needed when dealing with lending institutions, property settlements and estate proceedings.
If you are looking to sell your business, I highly recommended getting a formal business valuation.
Valuation vs. Appraisal: Differences
The main difference between a valuation and appraisal is the purpose of each method. A valuation aims to determine the overall value of the business, while business appraisal seeks to determine the value of specific assets within the business.
An appraisal gives the estimated price of a business but isn’t legally binding whereas valuation provides a definitive value that can be used for legal purposes.
Typically, an appraisal is just one part of a comprehensive business valuation.
How to Choose between Valuation and Appraisal
The decision will depend on your specific circumstances and the reasons you’re seeking to determine the value of your business.
As I mentioned above, if you’re seeking to sell your business, you’ll likely need to have a business valuation.
Regardless of your specific situation, it’s important to work with an M&A advisor who has experience in both business valuation and business appraisal. A qualified professional will be able to advise you on the best way to proceed for your unique situation.
Pros of Valuation:
- Provides a comprehensive understanding of the overall value of your business
- Can help you make informed decisions about selling your business or making other major financial transactions
- Can help you receive the best possible return on your investment when selling your business
- Can be used to support your asking price during negotiations with potential buyers
- Can help you make informed decisions about securing financing, such as a loan or investment
Cons of Valuation:
- Can be time-consuming and expensive, especially for larger or more complex businesses
- Relies on projections and mathematical models, which can be subject to error
Pros of Appraisal:
- Provides a more specific and accurate understanding of the value of specific assets within your business
- Typically less expensive than a full business valuation
- Quicker turnaround compared to a full business valuation
Cons of Appraisal:
- May not accurately reflect the overall value of your business
- May not consider factors that can impact the value of your business as a whole, such as market conditions or financial performance
- Can be limited in scope and may not provide a holistic understanding of your business’s value
- May not be suitable for larger or more complex businesses with multiple assets and operations
Valuation vs. Appraisal FAQs
1. What is a business valuation?
Business valuation is a process that seeks to determine the fair market value of a business. This is an estimate of what a buyer would pay for your business if it were for sale on the open market.
There are three common methods of valuation: the income approach, the market approach, and the asset approach.
2. What is a business appraisal?
While a valuation is designed to determine the overall value of a business, business appraisal is designed to determine the value of specific assets within the business.
For example, you might need to determine the value of your company’s machinery, intellectual property, or real estate.
3. What’s the difference between business valuation and business appraisal?
The main difference between a valuation and appraisal is the purpose of each method. Business valuation aims to determine the overall value of the business, while business appraisal seeks to determine the value of specific assets within the business.
4. Why do I need a business valuation or business appraisal?
If you’re seeking to sell your business, you’ll likely need to have a business valuation. But if you’re looking to sell a specific asset within your business, you may need to have that asset appraised.
Here are a handful of examples when these can be particularly useful:
- If you’re looking to sell your business
- Dividing purchase price between business partners
- Figuring out the value of each partner’s ownership interest
- Resolving issues around gift taxation and estate planning
- If you’re involved in divorce litigation
5. How do I choose between business valuation and business appraisal?
The decision between business valuation and business appraisal will depend on your specific circumstances and the reasons you’re seeking to determine the value of your business. A professional with experience in both methods will be able to advise you on the best way to proceed.
6. Can I do a business valuation or appraisal on my own?
While it’s technically possible to do your own business valuation or appraisal, it’s not recommended. Business valuation and appraisal require specific knowledge, expertise, and experience that can only be gained through professional training.
Not to mention, errors in your valuation or appraisal could have significant financial consequences, so it’s best to work with a professional to ensure you receive an accurate estimate of your business’s value.
7. How long does a business valuation or appraisal take?
The length of time it takes to complete a business valuation or appraisal will depend on the size and complexity of your business, as well as the method you choose.
On average, it takes several weeks to several months to complete a business valuation. Business appraisal typically takes less time, but can still take several weeks to complete.
8. What factors are considered in a business valuation or appraisal?
There are many factors that can influence the value of your business or assets, including your company’s financial performance, market conditions, competition, industry trends, and more.
A professional valuation or appraisal will consider all relevant factors to arrive at an accurate estimate of your business’s value.
9. Can a business valuation or appraisal help me negotiate a better price for my business?
A professional business valuation or appraisal can help you understand the true value of your business and provide you with solid data to support your asking price.
This information can be incredibly valuable during negotiations and can help you receive the best possible return on your investment.
Wrap Up
In closing, understanding the difference between business valuation and business appraisal is key for any business owner who are considering selling their business.
While both methods aim to determine the value of a business, they do so in different ways and for different purposes.
With the help of a professional, you can make an informed decision on which method is right for your business and help ensure that you receive the best possible return on your investment.
If you’re interested in a deeper dive, here are some related posts you might find helpful:
- How Much Does a Business Valuation Cost?
- Methods of Asset Valuation
- Service Business Valuation: 4 Easy Ways to Value a Service Biz
- Construction Company Valuation: 5 Key Factors
- Quality of Earnings Report: Everything You Need to Know
- Business Exit Planning: 16 Ways to Prepare Your Business for Sale
- Business Value Drivers: 20 Ways to Boost Your Exit Valuation
- Business Exit Strategy: How to Find the Perfect Buyer for Your Small Business
- 3 Ways to Increase Your Small Business Valuation Multiple (M&A Arbitrage)
