What's Your Company Worth? Whether you're selling your business, getting insurance or sorting through estate taxes, knowing your business's value comes in handy.
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Valuing a business is always an imprecise science, even withlarge-cap public companies. For example, is the value of a largepublic company based on its market price? Its book value? Itspotential worth if broken into parts that have more perceived valuethan the whole? The answer is, there are many ways to determine thevalue of a company. Perhaps the best way to understand the value ofany business, large or small, is to look at who's doing thevaluing and for what purpose. For example, we'll wager that youwould value your family business differently for estate purposesvs. a sale of the business. This is why in many instances, morethan one value can be correct.
Regardless of how a business is valued, there are bothquantitative and qualitative factors that play a role in acomprehensive appraisal. Many of the elements that go into abusiness valuation can be classified in three categories:
- "Hard numbers," such as historical profits, assets,cash flow and liabilities, are always important in determining theworth of a business.
- "Soft figures," such as income and cash-flowprojections, can be very important to a buyer or investorinterested in the company.
- "Intangible assets," such as patents, brand names,quality or reputation of management, location, recipes, customerlists or goodwill often have a hand in determining the overallvalue of a business.
As indicated above, two of the more common reasons to value acompany are for a sale or for estate tax purposes. Other purposesfor performing a valuation might include acquiring insurancecoverage of various types, attracting a new investor or seeking acredit facility from a bank or finance company.
The key considerations that go into any valuation include:
- Company, competitor and industry information. How isyour business performing, and how does it compare to yourcompetitors? What is the state of your industry? Is your businessin a growth industry or a declining one?
- Analysis of historical financial statements. Ratioanalysis such as return on equity or gross margin is oftenhelpful.
- Projected financial statements going out three to fiveyears can be particularly significant, especially if they arerecast to reflect the business without owner compensation. Byrecasting statements, the value can be estimated as if the businesswere under different ownership or managed under differentcircumstances.
- Using a method of valuation that is appropriate for thepurpose of the valuation.
Three popular approaches to value a privately held companyinclude:
2. Market comp approach. In this approach, privatecompanies are compared to comparable public companies. For example,if a similar public company is valued at, say, 23 times currentearnings, then that yardstick can be applied to determine the valueof the private company. When using multiples, private companies areusually adjusted downward because of the lack of liquidity inexchanging shares for cash. Non-financial comparisons might includecompanies with similar products, markets or industry criteria.Financial comparisons might include size (revenues), EBITDA, cashflow, price to book, price to earnings or M&A comps.
3. Discounted cash flow approach. Simply stated, thismeans that an analyst capitalizes an anticipated income stream orcash flow in the future. This is accomplished by discounting acompany's future income or cash flow at an assumed opportunitycost of capital. This is called bringing future anticipated incometo "present value." This approach will generally, but notalways, produce the highest value.
Most companies are valued for the purposes of a sale, merger orinvestment. For this reason, we must mention the concepts of fairmarket value and investment value. Fair market value is the valueestablished between a willing buyer and a willing seller-it'sjust that simple. And even though a seller and buyer may arrive atfair market value in entirely different ways, in essence, itdoesn't matter. Investment value, on the other hand, isgenerally regarded as FMV-adjusted (upward) for the specialbenefits that a buyer accrues from acquiring the new entity. Thesebenefits might include cost savings or added purchasing power.
The good news is, regardless of the valuation method employed orhow the value is determined, no one can claim you're wrong. Butdo keep in mind that not everyone will necessarily agree with yourassessment and may question the underlying assumptions that led toyour valuation. For serious valuations, there are a number ofprofessional services providers that specialize in valuing privatecompanies.
Bill Fiduccia is afounding partner of BizPlanIt, a professional business planning consultingfirm that helps early-stage, emerging-growth and establishedcompanies prepare clear, concise and compelling business plans thatget results.
