What's Your Company Worth?
Whether you're selling your business, getting insurance or sorting through estate taxes, knowing your business's value comes in handy.
By Bill Fiduccia
Valuing a business is always an imprecise science, even with
large-cap public companies. For example, is the value of a large
public company based on its market price? Its book value? Its
potential worth if broken into parts that have more perceived value
than the whole? The answer is, there are many ways to determine the
value of a company. Perhaps the best way to understand the value of
any business, large or small, is to look at who's doing the
valuing and for what purpose. For example, we'll wager that you
would value your family business differently for estate purposes
vs. a sale of the business. This is why in many instances, more
than one value can be correct. Regardless of how a business is valued, there are both
quantitative and qualitative factors that play a role in a
comprehensive appraisal. Many of the elements that go into a
business valuation can be classified in three categories: - "Hard numbers," such as historical profits, assets,
cash flow and liabilities, are always important in determining the
worth of a business.
- "Soft figures," such as income and cash-flow
projections, can be very important to a buyer or investor
interested in the company.
- "Intangible assets," such as patents, brand names,
quality or reputation of management, location, recipes, customer
lists or goodwill often have a hand in determining the overall
value of a business.
As indicated above, two of the more common reasons to value a
company are for a sale or for estate tax purposes. Other purposes
for performing a valuation might include acquiring insurance
coverage of various types, attracting a new investor or seeking a
credit facility from a bank or finance company. Content Continues Below
The key considerations that go into any valuation include: - Company, competitor and industry information. How is
your business performing, and how does it compare to your
competitors? What is the state of your industry? Is your business
in a growth industry or a declining one?
- Analysis of historical financial statements. Ratio
analysis such as return on equity or gross margin is often
helpful.
- Projected financial statements going out three to five
years can be particularly significant, especially if they are
recast to reflect the business without owner compensation. By
recasting statements, the value can be estimated as if the business
were under different ownership or managed under different
circumstances.
- Using a method of valuation that is appropriate for the
purpose of the valuation.
Three popular approaches to value a privately held company
include: 1. 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.
2. 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. 3. 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, 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 that specialize in valuing private
companies.
Bill Fiduccia is a
founding partner of BizPlanIt, a professional business planning consulting
firm that helps early-stage, emerging-growth and established
companies prepare clear, concise and compelling business plans that
get results.
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