What is the Difference Between a Business Appraisal and a Business Valuation?

Difference Between a Business Appraisal and a Business Valuation

If you're selling a business, you might be considering getting a valuation. But before you dive in, it's important to understand the difference between a business appraisal and a business valuation, and why it matters.

Think of it like getting your house valued. A real estate agent will provide you with an appraisal based on market trends and recent sales in your area. However, when a bank assesses your property for a loan, they conduct a formal valuation that follows strict financial criteria (though usually still looking at recent sales and comparables).

A similar same distinction applies to business sales - one is an estimate, while the other is a detailed financial assessment.

But its important to keep in mind, business sales and real estate are very different. Businesses are alot more complex and the process to value them is much harder than 4, 2, 2, on a 600sqm block. Also in business sales, there are much less comparables and potential buyers!

So lets take a look at the difference, how they are determined and why you might use an appraisal or a valuation. 
 

What is a Business Appraisal?

A business appraisal is an estimated selling price usually provided by a business broker or real estate agent.

It’s similar to a real estate appraisal but there is some marked differences, as businesses are alot more complex with much fewer comparables.

Business brokers base their assessment on recent sales, industry knowledge, and basic financial information from the business. The process is typically informal and designed to give business owners a rough idea of what their business might fetch in the market. 

Often business brokers will use a benchmark or multiple to arrive at the number. Say for instance a cafe is very well established, with a good lease, management in place, they may give it a 2.5 multple on net profit. So if the business is netting $100,000, then it maybe valued at $250,000. This is a very simple calculation for an example, but this is often how an initial appraisal is made. 

The multiplier is based on a few factors such as industry, and stablity of the business. If the business relies heavily on the current owner such as Sally's Hair Salon, and most clients are coming so that Sally can cut their hair, then the business may have a much lower multiplier around 1-1.5. 

Most brokers offer appraisals for free as part of their sales process. The downside? There’s no set formula. If you get three appraisals from different brokers, you could receive three very different price ranges. Appraisals often factor in elements such as goodwill, location, customer base, and market trends, but they are not legally binding.

While a business appraisal can be useful in setting expectations, it’s important to recognise that it is ultimately a selling tool, not a definitive valuation of the business’s worth. 

There are a few issues with appraisals, such as brokers over inflating the asking price to get your business, fast forward 6 months and you are lowering the price $50,000 to meet the market demands. So as the business owner you need to understand what is available and get multiple appraisals to make an informed decision. 

 

What is a Business Valuation?

 

A business valuation, on the other hand, is a detailed and formal financial assessment conducted by an accredited business valuer.

This process is far more in-depth and follows specific valuation methodologies to determine an accurate figure. Valuations are often required for legal, financial, or taxation purposes.

Business valuers typically hold certifications from recognised organisations such as the Australian Institute of Business Brokers (AIBB), Chartered Accountants Australia, or the Australian Property Institute (API). A formal valuation may be required for:

• Securing business loans or refinancing
• Legal disputes, such as divorce settlements or shareholder agreements
• Tax purposes, including capital gains assessments
• Insurance purposes
• Succession planning and estate settlements

Unlike an appraisal, a business valuation provides a comprehensive report based on financial statements, assets, liabilities, future earning potential, and industry benchmarks. These valuations take time, often requiring weeks of analysis and documentation.
 

How Much Does a Business Valuation Cost?

Business valuations in Australia typically range from $4,000 to over $10,000, depending on the size and complexity of the business. For businesses under $3 million, valuations tend to sit within the lower range, while larger businesses require more detailed assessments, increasing the cost.

While expensive, a valuation offers an independent and legally defensible assessment of a business’s true worth. If you’re selling, it can help justify your asking price to buyers. 

The trick with valuations is, even though your business may be valued at $1 million, your next strategy is ensuring there is market demand and you can find the right buyer to purchase the business. The way to win that battle is to ensure your business is properly prepared for sale and to engage experts in the process. 

 

 

Should You Get an Appraisal or a Valuation?
 

It depends on your purpose, and the size of your business. 

If you’re just exploring the idea of selling, obtaining at least 3 appraisals from business brokers can provide you an asking price when you start to sell your business. This will help in setting the asking price for your business. Then you need to take it to market to find the buyer. 

If you need an accurate valuation for legal or financial reasons, a formal business valuation is the better option. If your selling a business and there are multiple partners, obtaining a valuation may be important to ensure the sale is handled correctly and funds are distributed correctly. 

Understanding the difference between an appraisal and a valuation can save you from unrealistic expectations and potential financial mistakes.

It’s always wise to seek professional advice before making a final decision, as you dont want to make some of these costly mistakes. 

 

Originally published 2019

Tags: selling a business valuations

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