In our earlier blog, “Positioning Your Company for Sale,” we identified a business valuation as a key initiative. This article looks more closely at the various approaches and identifies specific items that can directly influence that valuation. There are three main business methods:
Asset Valuation: In this approach, the valuer will determine the market value of the assets and subtract the liabilities to arrive at a net value for the business. If the sale is made on a going concern basis (i.e., an orderly sale), the valuer may also place an additional value component on intangible assets, such as goodwill, customer lists or intellectual property. If the sale is to be made on a liquidation basis (i.e., a forced sale), then there will be a discount applied to the tangible assets and no value assigned to intangible assets.
Earnings or Revenue Multiple: The Earnings Multiple method is built on the foundation that the past earnings and cash flows of the business are sustainable to generate continued future wealth. The most common approach is to apply a multiple to the Earnings Before Interest Taxes Depreciation & Amortization (EBITDA) for the most recent year or some average of the last three years. A variation on this approach is a multiple of revenue, since that can be a predictor of future earnings for companies more dependent upon longer term construction contracts. Compared to the Asset Valuation method, a business with a solid track record of sustainable earnings will typically attract a higher valuation than the Asset Valuation method.
Market Value: In this approach, the valuation is based on similar transactions that have taken place by comparing the potential seller’s business to recently closed sales. Unfortunately, selling a business is not like selling a house or a car, since no two are generally alike and there often exist market, product or competitive specifics that can make any comparison complex.
A professional valuer will also seek to identify other elements as part of performing the valuation, including:
- Re-stated earnings, to remove owner-specific or non-recurring expenses included in historical financial statements
- Non-competition agreements that will protect the buyer from having the prior owner become a competitor
- Real estate holdings, depending upon whether they are included as assets to be sold versus a lease arrangement
- Synergies with potential buyers that may attract enhanced value depending upon the buyer’s unique market position and operating capability
We advise our clients not to rely heavily on any one approach. It may be that some combination of all three is appropriate to reach an objective range of value. There is no precise answer, since different buyers may have varying perceptions of value.
A final point to offer is that business owners should resist from performing their own valuation. Invariably they have too much invested emotion along with a biased view of value to be able to make an objective assessment. Engage the services of a professional business advisor such as The Roebuck Group who possesses the skills and industry-specific experience to maximize your valuation.