VALUATION METHODS
How are Companies Valued?There are multiple valuation methods for companies, much like there are for real estate. The most common starting point, is an Industry Professional’s Valuation Opinion, much like your Real Estate Agent presenting their Value Opinion of your house or building. Once companies are larger, with many more variables (real estate, large assets such as equipment/vehicles, Intellectual Assets, etc..) then there are more formal Valuation Methods to be engaged.
FIRST – Why Would You Need a Business Valuation?
- When looking to sell your business
- When looking to merge or acquire another company
- When looking for business financing or investors
- For divorce proceedings
- For certain tax purposes
- When establishing partner ownership percentages
- When adding shareholders
There are a handful of common reasons why business owners need to evaluate the worth of their company:
Ultimately, different small business valuation methods will be preferable in different scenarios. Generally, the best approach will depend on why the valuation is needed, the size of your business, your industry, and other factors such as ownership of real estate or other assets.
For example, in a company sale situation, most private small businesses are sold as asset sales and a value placed upon the sellers earnings, whereas the majority of middle-market transactions involve the sale of equity. Each of these sales could require a different business valuation method.
Valuation Methods
Most Common Business Valuation Methods
SDE & Revenue Multiplier (Smaller Companies)
Smaller companies are often sold based upon a standard revenue multiplier (based upon other same industry sales) or a multiplier of the Seller’s Discretionary Earning and the value of the assets.
Discount Cash Flow Valuation
If profits are not expected to remain stable in the future, use the discount cash flow valuation method. It takes your business’s future net cash flows and discounts them to present day values. With those figures, you know the discounted cash flow valuation of your business and how much money your business assets are expected to make in the future.
Historical Earnings Valuation
A business’s gross income, ability to repay debt, and capitalization of cash flow or earnings determines its current value. If your business struggles to bring in enough income to pay bills, its value drops. Conversely, repaying debt quickly and maintaining a positive cash flow improves your business’s value. Use all of these factors as you determine your business’s historical earnings valuation.
Asset Valuation
Your company’s assets include tangible and intangible items. Use the book or market value of those assets to determine your business’s worth. Count all the cash, equipment, inventory, real estate, stocks, options, patents, trademarks, and customer relationships as you calculate the asset valuation for your business.
Relative Valuation
With the relative valuation method, you determine how much a similar business would bring if they were sold. It compares the value of your business’s assets to the value of similar assets and gives you a reasonable asking price.
Future Maintainable Earnings Valuation
The profitability of your business in the future determines its value today, and you can use the future maintainable earnings valuation method for business valuation when profits are expected to remain stable. To calculate your business’s future maintainable earnings valuation, evaluate its sales, expenses, profits, and gross profits from the past three years. These figures help you predict the future and give your business a value today.
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