When business owners start thinking about selling, they will usually encounter two kinds of services for valuing their business: business appraisals and business valuations. While these are often treated as the same, there is a big difference between the two. Understanding that difference is important for deciding how to assess your business’s value and make informed decisions as you prepare to sell.
In this blog, we will look at business appraisal vs valuation, including what each process involves, who conducts them, and when to use each. We will also cover the main differences between the two and the role they play when valuing a business.
What Is a Business Appraisal?
A business appraisal is an informal assessment of what a business might sell for in the current market. It is commonly conducted by a business broker or another experienced advisor reviewing recent sales, market conditions, and the business itself.
An appraisal can take into account factors such as:
- Recent sale prices of similar businesses in the same industry and region
- Current market demand
- The business’s trading history and financial performance
- Location and lease terms
- Staff and how the business operates
- Industry and economic conditions
What Is a Business Valuation?
A business valuation is a formal assessment of the business’s value. It is generally prepared by a qualified professional with experience in business valuations, using recognised valuation methods and paying attention to the purpose of the valuation.
Situations that call for a business valuation may include:
- Partnership disputes or buyouts
- Divorce or family law proceedings
- Mergers and acquisitions
- Estate planning and succession
- Capital raising or financing arrangements
- Litigation and tax matters
The Main Difference Between Business Appraisals and Valuations
The main difference comes down to purpose and formality. A business appraisal answers the question: “What could this business sell for in the current market?” On the other hand, a business valuation answers the question: “What is this business worth for legal or financial purposes?” Appraisal focuses on the market, while valuation provides a more formal assessment of value.
This does not make one better than the other. They are used for different purposes. An appraisal can be appropriate when an owner is considering a sale and wants to understand what the business could achieve in the market. A formal valuation may be required when the value must be supported by detailed analysis and formal documentation.
When Is a Business Appraisal Useful?
An appraisal is the right starting point for most business owners considering a sale. It gives you a realistic view of what buyers in the current market are actually paying for businesses like yours.
A business appraisal is useful when you:
- Are thinking about selling your business in the near future and want to plan accordingly
- Want to understand how your business compares to recently sold businesses in the same sector
- Are deciding whether now is the right time to sell
- Need a benchmark before listing your business
When Is a Business Valuation Necessary?
A formal valuation is needed when a buyer or investor requires a certified business value for financing purposes. Unlike an appraisal, it carries professional accountability and follows legally robust methodology.
You typically need a formal business valuation when:
- You are involved in a legal dispute with a business partner or co-owner
- The business is part of a divorce or estate settlement
- A buyer or investor requires a certified figure for financing purposes
- You are preparing for a merger or acquisition with formal due diligence requirements
- The Australian Taxation Office (ATO) requires a defensible value for tax purposes
It is worth noting that a formal valuation does not always reflect what a buyer will pay. Market sentiment, timing, and negotiation all affect the final sale price. A valuation gives you a methodically derived figure; an appraisal gives you a market-based expectation.
How Is a Business Appraisal Conducted?
A business appraisal generally involves the following steps:
- Price range recommendation: The broker provides a realistic price range and, in many cases, a recommended asking price based on what buyers are currently willing to pay.
- Initial consultation: The broker meets with the business owner to understand the business, its operations, financial performance, and the owner’s goals.
- Financial review: The broker reviews available financial information, such as profit and loss statements and other relevant records, to assess the business’s earnings and financial performance.
- Market comparison: The broker considers comparable businesses, including those currently on the market or that have recently sold. Comparisons may take into account factors such as industry, business size, location, financial performance and business model.
- Assessment of other factors: Factors such as the customer base, lease arrangements, staff, assets and the overall condition of the business may also be considered.
- Market price indication: Based on the information reviewed and current market conditions, the broker may provide a realistic price range and, where appropriate, recommend an asking price.
How Is a Business Valuation Conducted?
A formal business valuation involves applying an appropriate valuation methodology based on the nature of the business, the information available and the purpose and scope of the valuation. Depending on the circumstances, one or more recognised approaches may be considered. Common approaches include:
- Capitalisation of earnings: The business’s usual or expected profits are used to estimate how much the business is worth. This method works best for businesses with steady and predictable earnings.
- Discounted cash flow (DCF): The business’s expected future cash flow is estimated and then adjusted to reflect its current worth. This method can work well when future cash flow can be reasonably predicted.
- Asset-based approach: The value of the business is estimated by examining the worth of its assets and subtracting any debts or liabilities. This method can be useful for businesses that own significant assets.
- Market or comparable transactions approach: The business is compared with similar businesses that have recently been sold or valued. This helps estimate what the business could be worth based on current market conditions.
Key Takeaways
Understanding the difference between a business appraisal vs valuation can help you make better decisions when preparing to sell your business. An appraisal gives you an indication of what your business may be worth in the current market, while a formal valuation provides a more detailed assessment of its value.
If you are considering selling your business in Queensland and want an honest, market-based view of its worth, the team at Stockbridge Business Brokers can help. We use current market data and comparable sales to provide a realistic indication of your business’s market value. Book an appraisal today.