In a recent post, we discussed how important it is for entrepreneurs and business owners to have a realistic understanding of the value of their company. Regardless of whether you are just starting out with a business plan hot off the printer, your getting ready to raise capital or are preparing to sell your company, understanding the real market value of your company is critical. Being fully aware of the value of your business at this moment in time will enable you to make rational decisions on your company’s short and long-term future.
In the first part of this article series we discussed how both quantitative and qualitative factors such as “hard numbers”, “soft figures” and “intangible assets” play a role in a comprehensive appraisal. We have also reviewed the key considerations that go into any valuation such as company, competitor and industry information as well as historical financials and forward looking projections.
The next question becomes which valuation approach will you and your market analysts or business appraisers choose to utilize? You want to be sure to use a method of valuation that is appropriate for the purpose of the valuation. The three popular approaches to value privately held companies include:
- Balance Sheet Approach. This is the easiest way to value a business. It will more often than not, however, produce the lowest valuation. A company’s book value is simply a firm’s liabilities subtracted from its assets. Banks and insurance companies are often valued on this basis. Many analysts believe that using an “adjusted book value” formula will produce a more accurate picture because this method takes into account the fair market value of assets and liabilities rather than a firm’s “historical book.” Liquidation value is another way of using a company’s balance sheet to arrive at a value. In this method, you simply calculate what’s left after the assets are sold and the debts are paid. What’s left is the value.
- Market Comp Approach. In this approach, private companies are compared to comparable public companies. For example, if a similar public company is valued at say, 23 times current earnings, then that yardstick can be applied to determine the value of the private company. When using multiples, private companies are usually adjusted downward because of the lack of liquidity in exchanging shares for cash. Non-financial comparisons might include companies with similar products, markets or industry criteria. Financial comparisons might include size (revenues), EBITDA, cash flow, price to book, price to earnings or M & A comps.
- Discounted Cash Flow Approach. Simply stated, this means that an analyst capitalizes an anticipated income stream or cash flow in the future. This is accomplished by discounting a company’s future income or cash flow at an assumed opportunity cost of capital. This is called bringing future anticipated income to “present value.” This approach will generally, but not always, produce the highest value.
Most companies are valued for the purposes of a sale, merger or investment. For this reason, we must mention the concepts of fair market value and investment value. Fair market value is the value established between a willing buyer and a willing seller – it’s just that simple. And even though a seller and buyer may arrive at fair market value in entirely different ways, in essence, it doesn’t matter. Investment value on the other hand, is generally regarded as FMV adjusted (upward) for the special benefits that a buyer accrues from acquiring the new entity. These benefits might include cost savings or added purchasing power.
The good news is that regardless of the valuation method employed or how the value is determined, no one can claim, “You’re Wrong.” But, do keep in mind that not everyone will necessarily agree with your assessment, and may question the underlying assumptions that led to your valuation. For serious valuations, there are a number of professional services providers throughout the United States that specialize in valuing private companies. Be sure to check their qualifications and ask questions until you feel comfortable with their level of expertise and experience.
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About the Author, Jimmy Lewin
