Valuation FAQs

Q. What are top methods for valuing a business?

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“Valuing a closely held business is like forecasting the weather:
Everyone wants an absolute, scientifically determined, accurate
answer, but no one has come up with a way to achieve this goal. If
there is one thing that everyone can agree on, however, it is that
business valuation is an art, not a science. All the statistical,
mathematical, and economic formulas concocted over the years
cannot determine with certainty the value of a going business to a
specific party over a future time period.”

Lawrence W. Tuller – The Small Business Valuation Book

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A) Valuing a Business based on Cash Flow and Risk

Preferred by professional business appraisers and savvy investors, the Discounted Cash Flow method lets you determine the value of a business based on three fundamentals:

• Business cash flow stream.
• Discount rate which captures the business risk.
• Long-term (terminal) business value.

Accurate valuation of businesses large and small

Discounted Cash Flow is considered the most accurate business valuation method. Its strength lies in business value estimation based on the precise match between the business earning power and risk. You can accurately determine the value of any business – large or small – using this powerful business valuation method.

Valuation of established companies and start-ups

This business valuation method is the tool of choice for valuing both the established businesses and start-ups – since it works directly on the business earnings forecasts. High growth businesses or firms with significant earnings upside are particularly well suited for business valuation using the Discounted Cash Flow method.

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B) Business Valuation based on Multiple of Earnings

For owner-operator managed private businesses, the Multiple of Discretionary Earnings business valuation method offers an excellent way to measure what a business is worth. This income-based business valuation method determines your business value based on several inputs:

• Business discretionary earnings.
• Working capital and business long-term liabilities.
• A number of key business financial and operational performance criteria.

Business valuation based on key value drivers

One of the greatest strengths of this method is that it gives you the ability to see how a number of important factors affect business value. Once you see how sensitive your business value is to, say, its customer base concentration, or current product mix, you can make strategic decisions that increase your business worth.

Thus, you can use Multiple of Discretionary Earnings as both the business value measurement and strategic planning tool. Business value changes with time. Your business valuation today may provide a reference point on which to base forward-looking changes.

Business value measurement and strategic planning tool

Armed with the knowledge of what drives your business value, you as the business owner can make far-reaching improvements that focus on growing your business worth. As time goes on, you can assess the effect of your efforts by repeating your business valuation. This lets you see how smart business choices translate into increased business value.

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C) Valuing a Business based on Market Comparisons

Market Comparisons approach offers you perhaps the most compelling way to determine the business value. Many business people and appraisal experts believe the market to be the ultimate judge of what a business is worth.

In this sense, the business market value is revealed by the price the business fetches in an actual sale. Comparison against the sales of similar businesses is the next best thing – you can gather enough statistical evidence to price your business quite accurately.

Key uses of the market-based business valuation

Determining your business value by such market comparisons is especially useful in these situations:

• To set an asking price or offer price for a business acquisition.
• To defend your business valuation in a legal controversy or before the tax authorities.
• To justify your business value in a dispute such as partner disagreements or buyout.

Business fair market value estimation

Market comparisons are an excellent way to estimate the very important fair market value of a business. This is by far the most common measure of business value – and is the de-facto standard used in most business valuations.

Valuation Multiples: business value calculation

You can use a number of valuation multiples to estimate your business fair market value. All such multiples are statistically derived ratios that relate the potential business selling price to some measure of its financial performance.

Using the valuation multiples derived from comparable business sales, you can determine what your business is worth based on its recent revenues, net income, discretionary cash flow, EBITDA, total assets or book value, among others.

For example, you can take the Price to Gross Revenues Multiple and multiply it by your business revenue figure. The result is the market-based estimate of what your business is worth.

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Pricing and Terms that Make Sense

Ask an experienced business broker and you will hear this disturbing statistic: Four out of five small businesses never sell.

Why? Here is the top reason: Business owners and buyers do not agree on the business selling price and terms.

Why is it so hard? Below are the top 8 factors that make a business sale a success … or failure. Consider these key factors that can make or break a sale, beyond the business selling price:

• Cash up front: what is the amount of buyer down payment?
• Is seller and bank financing available on reasonable terms?
• Does the business offer a living wage for the new owners?
• Payback period: how long will it take for the buyer to get the down payment money back?
• Capital expenses: what additional funds are needed to keep the business running?
• What level of working capital does the buyer need to provide, beyond the business purchase price?
• Is business cash flow enough to cover the debt service?
• Reasonable transaction costs that include business licenses and permits, professional fees, due diligence expenses and closing costs.

Business selling price and terms that work

Business cash flow must be sufficient to cover all of the above for the deal to work. With so many “moving parts” in a typical small business sale and purchase negotiation, making sure this is so is no easy task.

Call Sterner Consulting for more information on obtaining an accurate valuation for your business.

[Source: ValueAdder – Business Valuation Tools]