What to Watch Out for When Estimating Business Value?

Estimating business value is a crucial step in many situations -- whether it involves selling a business, marital property settlement, probate proceedings, or finding an investor. A quality valuation can help prevent unnecessary disputes and ensure fair distribution of assets. Yet errors often occur during valuations that can fundamentally affect the resulting business value. So how should you proceed correctly and what should you watch out for?

Contents

• 1. Who Can Perform a Business Valuation?
• 2. Selecting the Right Valuation Method
• 3. Quality of Input Data and Their Correct Interpretation
• 4. Failure to Account for Intangible Assets
• 5. Impact of Competition and Economic Factors
• 6. Tax Optimization Can Distort Profits
• 7. Independence of the Appraiser and Objectivity of the Valuation
• 8. Summary

1. Who Can Perform a Business Valuation?

The first and most important rule is that a business valuation should always be performed by a person with the appropriate authorization. In the Czech Republic, a valuation can only be performed by:

• A person with a trade license for property valuation, which includes valuation of businesses (business enterprises). This activity falls under a licensed trade and requires meeting the professional conditions set by the Trade Licensing Act -- see Property Valuation for Business Enterprises, Sections 23 and 24 of Act No. 455/1991 Coll. We recommend verifying the trade license for this activity on the Business Registry Portal.
• A court-appointed expert, appointed by the Ministry of Justice of the Czech Republic under Act No. 254/2019 Coll., on Experts, Expert Offices, and Expert Institutes. An expert appraisal is often required by courts or authorities in legally binding proceedings. The list of court-appointed experts, expert institutes, and offices can be found on the Ministry of Justice website.

If a valuation is performed by someone who does not have the necessary qualifications or authorization, it may result in an incorrect valuation that will not be legally recognized or the calculated result may not be computed correctly.

2. Selecting the Right Valuation Method

There are several valuation methods, each suited to a different type of company and situation:

• Asset-based method: The company's value is derived from the value of assets minus liabilities. This method is suitable for companies with significant tangible assets (e.g., manufacturing companies, real estate firms, companies focused on asset management and holding).
• Income method (DCF -- Discounted Cash Flow): Takes into account the company's future income and its present value. It is used primarily for businesses with long-term stable cash flow.
• Market comparison (Comparative method): The company's value is estimated based on the prices of similar companies on the market. Unfortunately, in the Czech Republic there is insufficient market data for this method to be used more frequently and to find broader application as it does in developed markets such as the USA or Western Europe.

What to watch out for? Each method can produce a different resulting value. An inappropriate method can cause overvaluation or undervaluation of the business, which can have fundamental consequences when distributing assets or negotiating with investors.

3. Quality of Input Data and Their Correct Interpretation

A valuation is only as accurate as the input data. The most common errors arise from incorrect financial data:

• Review the financial statements for the last 3 years, preferably 5 years (Balance Sheet, Profit and Loss Statement). More in our earlier article.
• Take into account current debts, receivables, and extraordinary expenses that may distort the financial result.

If the data is incorrect or incomplete, it may result in an inaccurate valuation that does not reflect reality. All calculated values must be adequately justified and substantiated. The sources where this information can be verified must also be cited so that their accuracy can be confirmed.

4. Failure to Account for Intangible Assets

Many companies have value not only in tangible assets but also in intangible assets that accounting often does not adequately reflect:

• Strong brand and company reputation
• Know-how and unique technologies
• Customer database
• Long-term contracts and partnerships

If these assets are ignored in the asset-based method, the company's value may be significantly undervalued.

However, the benefits generated by intangible assets can be seen in the profit and loss statement, where they contribute to corresponding revenues.

5. Impact of Competition and Economic Factors

A company's value is not just about numbers -- it is also about the market, competition, and economic environment. For example:

• What is the competitive situation in your industry?
• Is the business cyclical or stable?
• What are the current trends (e.g., digitalization, automation, new regulations)?

If a company is valued without regard to these factors, the valuation may be misleading.

6. Tax Optimization Can Distort Profits

Companies often adjust their accounting for tax purposes -- for example, by reducing profits through higher depreciation or including certain expenses in operating costs. This can distort the company's actual economic performance.

When valuing, it is therefore necessary to adjust accounting results to reflect actual economic indicators.

7. Independence of the Appraiser and Objectivity of the Valuation

A business valuation should be transparent and independent. A common problem is that:

• The seller wants a higher valuation to sell the company for as much as possible.
• The buyer wants a lower valuation to reduce the purchase price.
• In marital property settlements, one spouse may want to artificially reduce the business value.

Therefore, it is important that the valuation is performed by an independent and professionally qualified person.

8. Summary

• The valuation should be performed by a person with a trade license or a court-appointed expert.
• The valuation method(s) used must correspond to the type of company and purpose of the valuation.
• It is necessary to have correct and complete data -- accounting records, receivables, liabilities.
• Account for intangible assets, which in some cases can constitute a large portion of the value.
• Consider competition and the market environment, which affect the company's value.
• Watch out for tax optimization, which can distort results.
• The valuation should be impartial and as objective as possible, although as we continually emphasize, every valuation is the subjective opinion of the appraiser or expert, who should be able to defend it.

If you keep these factors in check, you will obtain a quality and realistic business valuation that will stand up in any negotiation or legal proceeding.