Business Valuation (Part 1 of 2)
What is Business Valuation?
Wondering how does business valuation differs from property valuation? “How much is my business worth?” – a question that business owners will always ask. It seems like a simple question but there is no straight forward answer to it.
Business valuation is both a series of theoretical models and market reality. It incorporates consideration of historical performance, future expectations, tangible and intangible assets, perceived risk, synergies, industry factors, comparable business assets, and other matters deemed necessary to be taken into consideration. How these components are interpreted can bring a great difference to the valuation outcome.
Although some of these components can be determined using mathematical models, many are based on professional judgment. That is why business valuation is regarded as combination of both science and art.
The science component includes analysis of historical performance, mathematical models, statistical data, and information on sale of comparable assets. The art component includes opinions of the professionals, forecasts for the business and economy, assessments of risks, and expectation of future returns.
The Need for Business Valuation
The need for valuation services is increasing, driven by various economic and societal factors. In the following table, we outline the various activities that create the needs for valuation services. These are non-exhaustive as business owners are getting more concerned about the value of their businesses and the options they can derive from there.
|Business Transactions||Litigations||Shareholder Transactions||Corporate Status / Mandate|
|Mergers & Acquisitions |
Sales & Divestitures
Purchase Price Allocation (Financial Reporting)
Breach of Contract
Breach of Fiduciary Duty
In business transactions, valuation is commonly required as it forms the basis of negotiations and decision makings. Without knowing the value of an entity, buyers and sellers will face difficulty in finding a starting point in their negotiation towards closing the deal.
Mergers & Acquisitions (“M&A”)
Value is exchanged when businesses are acquired or merged. Many mergers and acquisitions are completed without both buyers and sellers understanding their values. Business valuation can help buyers minimise the chance of over-paying. Whereas for the seller, business valuation can help increase the probability of closing a transaction. Valuation enables all the parties to ensure that they receive or pay the appropriate consideration in a merger and acquisition.
Sales and Divestitures
In a sale or divestiture, a professional business valuer is normally engaged to establish a range of values of the business in order to assist the parties in their negotiations.
The objective of valuation is to establish a realistic price on the entity to maximise sale proceed. A thorough and professional independent valuation would be able to minimise the negotiations over price and help to make the sale process easier for everyone.
It is common that different parties jointly contribute into a new company or through the acquisition
of a joint venture entity. In either case of joint venture, in order to properly establish the contributions of each partner, the valuation of contributed assets (the business, its tangible and intangible assets) is required.
Valuation is essential in the planning and decision making process of the joint ventures in order to determine the appropriate value of the contributions for financial reporting purposes or separation in the future.
It has been a part of strategic planning of a company or group to identify and evaluate an entity’s potential opportunities and risks.
Through valuation, decision makers are equipped with thorough understanding of the value of an entity, which will help them evaluate strategic options or alternatives when it comes to planned activities or opportunities.
Purchase Price Allocation
Purchase price allocation is a requirement under the financial reporting standard for business combinations (mergers and acquisitions). Business combinations will bring fundamental impact on the buyer’s operations, resources and strategies. When one entity combines with another, the purchase price needs to be allocated between the fair value of both the tangible and intangible assets acquired and the liabilities assumed.
Reporting a business combination is a significant exercise. A qualified business valuer will be able to assist in the purchase price allocation under the requirement of the financial reporting standard.
(Sources: IACVS, Business Valuations)
Please stay tuned for Part 2 for further elaboration of the need for Business Valuation, which cover litigations, shareholders’ transactions, and corporate status or mandate.
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