The 8 Most Common Reasons Businesses Need a Valuation

Most business owners know roughly how much revenue their company generates. They may know how much cash is in the bank, how profitable the business was last year, or even what they think someone would pay to buy it.

But knowing those numbers is not the same as knowing what the business is actually worth.

A business valuation is a process used to determine the value of a business or ownership interest in a business. Depending on the situation, that value may be used for planning, negotiations, tax reporting, legal matters, or simply helping an owner make better decisions.

The important thing to understand is that a valuation is not only useful when someone wants to sell their business. In fact, waiting until the business is about to be sold is one of the most common times owners realize they should have understood its value years earlier.

Below are eight of the most common reasons a business may need a valuation—and why having one can make an important decision easier.

1. Buying or Selling a Business

This is probably the reason most people immediately think of when they hear the term “business valuation.”

If you are selling your business, you naturally want to receive a fair price. If you are buying a business, you want to make sure you are not overpaying.

The challenge is that business owners and buyers often have very different opinions about what a company is worth.

An owner may look at years of hard work, strong relationships, and future growth opportunities and believe the business is worth a premium. A buyer may focus more heavily on risks, customer concentration, declining margins, or the amount of capital required to keep the business operating.

A valuation helps bring an independent perspective into the conversation.

It does not necessarily mean that the final sale price will exactly equal the valuation amount. Buyers and sellers can negotiate for many reasons. Strategic value, financing terms, competition among buyers, and deal structure can all influence the final purchase price.

However, having a valuation gives both parties a starting point based on financial information and a structured analysis rather than simply guessing.

Without one, negotiations can become much more difficult.

2. Gifting Ownership to Children or Family Members

Many business owners eventually want to transfer some or all of their business to children, grandchildren, or other family members.

Before doing that, it is important to understand what is actually being transferred.

For example, suppose you want to gift 10% of your company to your child. How much is that 10% interest worth?

You cannot answer that question simply by guessing what you believe the entire business is worth. Depending on the purpose of the valuation, the characteristics of the ownership interest being transferred may also matter.

A valuation can help establish the value of the interest being gifted and provide documentation supporting that value.

This becomes especially important for tax and estate planning purposes. If the IRS ever questions the reported value of a transferred business interest, having a qualified analysis supporting the value can be significantly more helpful than simply saying, “This is what we thought it was worth.” It also helps decide whether gift tax returns are needed for the year or if the gift was below the annual threshold. 

A valuation can also help owners make better gifting decisions by showing how much ownership they are actually transferring and what that means financially.

3. Estate and Trust Planning

Business ownership can create complications when planning for death or transferring wealth to future generations.

If a business owner has significant wealth tied up in a privately held business, knowing the value of that business can be an important part of determining whether additional estate planning strategies should be considered.

Without knowing the value of the business, it can be difficult to understand the owner’s overall financial picture.

For example:

• How much of the owner’s estate is tied to the business?
• How much wealth is actually being passed to heirs?
• Would gifting strategies make sense during the owner’s lifetime?
• Should a trust or other planning structure be considered?
• Is there enough liquidity outside the business to handle potential obligations?

A business valuation does not answer every estate planning question, but it can provide one of the most important pieces of information needed to begin the conversation.

It is difficult to plan around an asset when nobody knows what that asset is worth.

4. Estate Tax and Date-of-Death Valuations

Estate planning is proactive. Estate administration is often reactive.

When a business owner passes away, the value of their ownership interest may need to be determined for tax reporting, estate administration, ownership transitions, or other legal purposes.

This can become particularly important when multiple heirs inherit the business.

Imagine three children inherit a company. One wants to continue operating the business, one wants to sell their ownership interest, and one has no interest in being involved at all.

Before anyone can begin discussing a fair solution, they need to understand what the ownership interests may be worth.

A valuation can provide an independent starting point for those discussions.

Without a valuation, disagreements can become personal very quickly. One family member may believe the business is worth millions more than another does. Having a professional analysis does not guarantee everyone will agree, but it provides something more objective to work from.

5. Divorce

Business ownership can also become an important issue during divorce proceedings.

If one or both spouses own a business interest, determining the value of that interest may be necessary when dividing assets or negotiating a settlement.

The business may be one of the largest assets involved, which makes simply estimating its value risky.

A business owner might believe the company has little value because it does not have significant cash sitting in the bank. However, a profitable company may still have substantial value because of its expected future cash flows, customer relationships, assets, or other characteristics.

On the other hand, a business generating substantial revenue may have less value than expected if profitability is weak or the business carries significant risk.

A valuation helps provide a more structured analysis of the business rather than relying solely on revenue, bank balances, or an owner’s personal opinion.

6. Buy-Sell Agreements and Ownership Disputes

Businesses with multiple owners should eventually have difficult conversations about what happens if one owner wants to leave, retires, dies, becomes disabled, or has a disagreement with the other owners.

Unfortunately, many businesses wait until one of those events actually happens.

A buy-sell agreement can help establish what happens in certain ownership transition situations. However, one of the biggest questions is often: How will the business be valued?

Some agreements use a predetermined value. Others use a formula. Others require a business valuation when a triggering event occurs.

The problem with predetermined values is that they can quickly become outdated.

Suppose the owners agree that the business is worth $2 million when they sign their agreement. Five years later, the business has doubled in size—but nobody updated the agreement.

Now an ownership transition occurs, and everyone realizes the old number no longer makes sense.

Regular valuations or clearly defined valuation procedures can help reduce this problem.

A valuation may also be useful when owners disagree about what the business is worth. Instead of each side simply arguing for the number that benefits them the most, an independent valuation can provide a more objective perspective.

7. Employee Ownership and Compensation Planning

As businesses grow, owners sometimes begin exploring ways to reward or retain key employees through ownership interests or ownership-like compensation arrangements.

Depending on the structure, understanding the value of the business may be important before deciding how much ownership to provide.

For example, if you are considering giving an employee a 5% ownership interest, you should probably understand what that 5% is worth before making the decision.

Valuation can also become important in employee stock ownership plans and other more complex employee ownership arrangements where specific valuation and compliance requirements may apply.

Even outside of formal ownership plans, a business valuation can help owners think strategically about how much equity they are giving up and whether the arrangement makes financial sense.

Ownership can be one of the most valuable incentives a business has—but it should not be handed out without understanding what is being given away.

8. Strategic and Exit Planning

You do not need to be actively selling your business to benefit from knowing what it is worth.

In fact, this may be one of the most overlooked reasons to get a valuation.

A business owner might ask:

• Am I financially prepared to retire?
• How much would I need to sell the business for?
• What parts of my business are creating the most value?
• What weaknesses may reduce the value of my company?
• How can I increase the value before I eventually sell?

A valuation can help begin answering those questions.

Maybe the business is profitable but heavily dependent on one customer. Maybe revenue is growing, but the owner is personally responsible for most customer relationships. Maybe the company has strong cash flow but poor financial records.

These issues may not always affect day-to-day operations immediately, but they can affect how attractive the business is to a potential buyer.

Knowing the value of your business years before an exit gives you time to make improvements.

Waiting until someone is ready to retire can leave an owner with limited options.

What Happens When You Don’t Get a Valuation?

Not every situation requires a formal business valuation.

However, making major financial, legal, or tax decisions without understanding the value of a business can create unnecessary problems.

Without a valuation, business owners may:

• Overpay when purchasing a business
• Accept too little when selling
• Make unsupported gifts of ownership interests
• Create disagreements between family members or business partners
• Make estate planning decisions based on inaccurate assumptions
• Give away more ownership than they realize
• Enter negotiations without understanding their bargaining position
• Discover value-related issues too late to fix them before selling

A valuation does not eliminate risk or guarantee a particular outcome.

What it does provide is information.

And when a major business decision involves millions—or even hundreds of thousands—of dollars, having better information can make a significant difference.

My Two Cents

Business owners often spend years building their companies without ever stopping to ask a simple question: What is this actually worth?

The answer matters more often than many owners realize.

You may not need a business valuation every year. You may not even need a formal valuation right now. But if you are considering selling, gifting ownership, planning your estate, bringing in a partner, preparing for retirement, or making another major ownership decision, understanding the value of your business can be an important starting point.

More importantly, knowing your value before you need to know it gives you options.

And in business, having options is often valuable in itself.

– Brendan Tiedeman, CPA, CVA

Disclaimer

This article is for educational and informational purposes only and should not be considered tax, legal, financial, or valuation advice. Business valuation requirements vary depending on the purpose, applicable laws, ownership structure, and specific circumstances. Consult with qualified legal, tax, and valuation professionals regarding your specific situation.