How do you know you are getting a fair price when you sell your business?
Many business owners spend years growing a business but only have a vague idea of what it is really worth. There are a number of methods to value a business. Sometimes the best way to assure a fair valuation is to consider a number of valuation methods.
The following are widely used valuation methods that can give business owners an estimate of what their business might be worth:
- Income approach. The income capitalization and discounted cash flow (“DCF”) methodologies are two common income approaches. The income capitalization method requires you to estimate a normalized cash flow (adjusted for unusual revenue or expenses), and divide it by a capitalization or discount rate to estimate the value of the business. The DCF method develops projections of cash flow (typically net income, plus depreciation and amortization, less capital expenditures and changes in working capital) which are then discounted at a rate commensurate with the risks inherent in the business. The sum of the present values of the cash flows, plus a residual value, provides an estimate of the value of the business.
- Market value approach. The guideline transaction and guideline company methodologies are two common market value approaches. The guideline transaction method attempts to identify transactions involving comparable companies, and develop multiples based on these transactions. This approach will only work if actual transactions involving comparable companies exist and if financial data relating to these transactions is publicly available. The guideline company method also develops multiples, but these multiples are estimated based on comparable publicly traded companies. Key factors to be considered in comparing entities include growth, risk and profitability. Adjustments may be necessary to reflect differences in marketability and control, depending on specifics of the subject company relative to the comparables.
- Asset based approach. The asset based approach is most appropriate for companies with little or no intangible asset value, such as start-ups or companies with little or no earnings and no established brands or history. The asset based approach attempts to break a company down into its pieces, such as inventory, equipment and real estate, and value each asset, and liability, separately. Another use of this approach is to determine the value of an investment holding company, whereby each underlying element is valued separately to determine the value of the holding company.
It’s important to note that these three valuation approaches are only a starting point. A comprehensive valuation will consider multiple valuation approaches and account for factors such as the history and market position of your business, competitive threats and marketplace opportunities. Further, existing economic conditions must be considered.
It has been said that trying to value your own business is like asking a mother how talented her child is. The blood, sweat, and tears you’ve put into your business may hinder your ability to determine a truly objective valuation. To make sure your company is valued reasonably, it helps to engage the help of a professional to undertake a careful process that considers all the relevant factors and combines multiple approaches to establish a real value for your business. This can be beneficial in preparation for sale negotiations, as well as for estate planning, insurance placement, or just general peace of mind.