Seven Critical Business Valuation Terms You Should Know

Target Audience: Business Owners, Financial Managers, Accounting Consulting Firm Advisement Interest, Business Owners, Buy-sell Agreements & Business Valuation Terms Interest

As a business owner, you’ll likely need to have your company appraised at some point. Appraisals are essential in the event you decide to sell or merge the business, create or update a buy-sell agreement, or devise or refine your estate plan. A good way to preempt the uncertainties of the appraisal process is to learn some basic valuation terminology. Here are seven terms you should know:

1. Fair market value. This is a term you may associate with selling a car, but it applies to selling a business (and their respective assets) as well. In a valuation context, “fair market value” has a long definition:

The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.

2. Going concern value. This important valuation term often comes into play with buy-sell agreements and in divorce cases. Going concern value is the estimated worth of a business that’s expected to continue operating in the future. The intangible elements of going concern often include factors such as having a trained workforce; an operational plant; and the necessary licenses, systems and procedures in place to continue operating.

3. The asset (or cost) approach. One of three common approaches that appraisers use to value businesses, this approach essentially calculates a company’s worth by adding up its assets net of liabilities. The approach can take a couple of different forms, including the adjusted book value method and the excess earnings method, which some experts consider a hybrid of the asset approach and the income approach discussed below. (Your appraiser will explain how these methods work.)

4. The income approach. Another one of three common approaches to valuing a business, the income approach derives a company’s value from its anticipated economic benefits. Common methods that fall under this approach include the discounted future earnings method and the capitalization of earnings method. (Your appraiser will explain how these methods work.)

5. The market approach. Yet another one of three common approaches to valuing a business for sale, here an appraiser uses one or more methods that compare the subject company to similar businesses, business ownership interests, securities or intangible assets that have been sold. Typical methods the appraiser might use are the guideline public company method and the merger and acquisition (M&A) method. (Your appraiser will explain how these methods work.)

6. Valuation premium. Sometimes, because of certain factors, an appraiser must increase his or her estimate of a company’s value to arrive at the appropriate basis or standard of value. The additional amount is commonly referred to as a “premium.” For example, a control premium might apply to a business interest that possesses the requisite power to direct the management and policies of the subject company.

7. Valuation discount. In some cases, an appraiser needs to reduce his or her value estimate based on specified circumstances. The reduction amount is commonly referred to as a “discount.” For instance, a discount for lack of marketability is an amount or percentage deducted from the value of an ownership interest to reflect that interest’s inability to be converted to cash quickly and at minimal cost.

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