What’s My Business Worth? – Part I

If you are a business owner, you are probably wondering what your business is worth.  Or perhaps you are an entrepreneur and are considering buying a business, what is a fair price?  Valuation analysis is a method to estimate the fair market value of a business. 

 In this series we are going to try to take some of the mystery out of valuation analysis.  In this first installment we are going to introduce some of the basic concepts of business valuation.  Our goal is to give you an overview of the valuation process and help you ask informed questions of your chosen valuation expert.   We are going to focus specifically on how we might go about valuing a privately-held company. 

This presentation contains general information about the valuation process.  It is not intended to give you advice about your own particular situation.  You should always consult with your own advisors and should engage a qualified professional to assist in any valuation assessment.  You can watch our presentation on video here, or read below.

What is a valuation report?

A valuation report is a defendable estimate, based upon established methodology, of the value of the business assets.

 Who might want a valuation report? 

• A business owner, perhaps contemplating the sale of a business, to set expectations for pricing. 
• An investor or buyer, would be interested in determining whether or not the asking price is consistent with the value of the purchase or investment. 
• A lender would want to know that there is substantial value, and that the business is capable of generating enough cash flow to service the debt and also provide an income to the owner. 
• A partner or shareholder in a private company, perhaps considering retirement or to settle a dispute. 
• The IRS, to establish market value of a company to assess tax. 
• Each of these potential users have a different perspective of the business’s value.

There could be several different value estimates, depending upon circumstances. 

Here are three of the most common.

• Fair Market Value (FMV) is the value at which a willing buyer and seller would agree to exchange ownership of the business in an arms-length transaction.  Fair market value is an accepted measure under tax law and in most courts, and is the value generally used in a business setting. 
• Replacement value is the cost to replace a particular asset, be it a piece of equipment, a building, or a company.  It may or may not reflect the fair market value, but in some circumstances, to settle an insurance claim for example, it may be the appropriate measure of value.
• Liquidation value, is the value which a buyer would pay in a distressed sale, such as a bankruptcy. 

In most business settings, we will be focused on fair market value.  We are interested in how to price a business for sale.

There are 3 general approaches to estimating value:

1. the asset approach,
2. the market approach, and
3. the earnings approach. 

In making a valuation assessment, the analyst would choose the approach that is most appropriate given the facts and circumstances of the situation.  Sometimes we might employ several, or all of the approaches to give us perspective, but in the end we will choose one as most appropriate.

•  The asset approach attempts to appraise the assets of the business, both tangible and intangible assets.  The asset approach may be the most appropriate approach in some circumstances.  The value of a gold or precious gem dealer, for example, could be based more on the inventory value than on the ongoing business, but in most cases a going concern business is worth more than its assets alone.  Note that asset approach is not the same thing as book value, which is the historical cost recorded on the company’s balance sheet.
• In a publicly traded company, we can easily compute the market capitalization of the company by multiplying the share price times the number of shares outstanding.  There is an established marketplace for ownership interests in publicly traded businesses.  Even here, however, the ultimate selling price per share for a controlling interest in a company could be worth more than its current price.  In a privately held or thinly traded company, it is not so simple.  There is no established share price.  We could look for recent sales of similar sized companies in the same industry.  The difficulty here is that most businesses are unique, we still need to make subjective adjustments to account for the differences between the example sales and the business under consideration, particularly looking at the circumstances of the example sale.  Was it between related parties, for example, or under duress?  
• The earnings or cash flow approach develops a financial model to estimate value.  The underlying theory here is that the assets of the business, in total, are in place for the purpose of generating cash flow.  Their collective value can be determined by looking at cash flow levels generated by those assets.  We then estimate the value of the cash flow stream.  We will take a more detailed look at determining and valuing cash flows in the next installment.

Summary

 I hope this has been informative.  In this installment we covered some of the basic concepts of valuation analysis.  In the next episode, we’ll talk about some ways to put a value on earnings.   Later, we’ll cover financial statement analysis.  Then we’ll put it all together with a valuation analysis of an example company.

 Cypress Business Partners offers a free estimate of the value of your business.  Please let us know how we can be of service to you.   Visit us on the web, or on Facebook.   If you would like to be informed when the next presentation is available, please send me your email address.  I promise to respect your privacy and will never share your information with anyone.

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