STANDARDS OF VALUE
How Much Is A Business Worth?
Valuation is the number one question of all sellers when contemplating a sale, and of course, the concern of most buyers when purchasing a company. Unfortunately, there are probably several answers.
Why? Because there are several standards of value for businesses.
Fair value
Legal standards to value. Both parties having knowledge of the relevant facts. Often used in divorce.
Investment value or strategic value
The value to specific buyers. Could exceed fair market value.
Asset Approach
Asset Approach values the assets of your business minus the liabilities.
- - Book Value
- - Net Asset Value (FMV of assets plus, sometimes, goodwill)
Market Approach
- - Market comparable (Similar company in type, size, etc.)
- - Public Company comparable
This is very much like in real estate, the property comparable method. Value is set by the similarities of properties sold and currently for sale. Comparable businesses in size and industry sell for similar valuations. It can be very reliable and, in most cases, is a strong indicator of value. Sometimes this can vary from business to business. Potential of a business is a huge factor that can increase the value immensely.
Income Approach
- - Discounted Free Cash Flow
- - Multiple of EBITDA
The business is worth the present value of the income stream it will bring to an investor. This approach is also a strong indicator of what a business with positive income is worth. These methods rely on future projections and growth rates. This is one of the most common methods
There are two methods used in this type of assessment for quickly approximating value:
- (1) applying a multiple to the discretionary earnings of the business
- (2) applying a percentage to the annual gross revenue of the business
These vary from a variety of factors, usually from the type of business and industry. Almost all privately held businesses will appraise for somewhere between one to five times earnings. Exactly where in this range that a specific business falls depends on the type of business. Wholesalers, distributors, manufactures, internet tech companies in general, are valued higher.
Smaller businesses, businesses with bad attributes have lower multiples and buyers usually want a faster ROI (rate of return). This usually is around 2.5 years, all dependent on the risk.