Business valuation is a process and a set of procedures used to estimate the economic value of an owner’s interest in a business. Valuation is used by financial market participants to determine the price they are willing to pay or receive to effect a sale of a business. In addition to estimating the selling price of a business, the same valuation tools are often used by business appraisers to resolve disputes related to estate and gift taxation, divorce litigation, allocate business purchase price among business assets, establish a formula for estimating the value of partners’ ownership interest for buy-sell agreements, and many other business and legal purposes such as in shareholders deadlock, divorce litigation and estate contest. Some people say valuing a business is more art than science. Nevertheless, having a realistic understanding of the value of your business or the value of your shares in a business is critical to personal decision-making and planning.
Valuation is never straightforward
The truth is that valuing a business isn’t always a simple or straightforward process. There is also a range of reasonable outcomes: there is no one single number that will ever be 100% precise. By definition, the value of business is determined by a proper assessment of the relationship between the future returns generated on an investment and the risk of attaining those returns.a.
In an ideal valuation, you would start with no preconceptions about the companies that you are analyzing and then make your best judgments on how much value to attach to them.
Uncertainty is a feature in valuation, not a bug, and it rises to the surface, especially when valuing young start-ups and companies in transition.
There are multiple forces that are converging to make valuations more complex.
The Bermuda Triangle of Valuation
It is true that valuation, at its core, is simple and should be easy to implement, but it is often mangled in practice. While some valuation malpractice reflects a misunderstanding of the basic principles of valuation, I think that the bigger culprit is the valuation process and three problems that are embedded in it: the biases that analysts bring into their valuations, their unwillingness to grapple and deal with the uncertainties that they face when valuing businesses and the ease of access to data and tools that allow them to build in complexities into valuation models.