When you're considering having your company appraised, one thing that may not have come to mind yet are the different small business valuation methods. But what are they, how are they different and which one should be applied to your particular situation? Here's a quick overview of the most common methods used and how they're applied to your company's situation.
What are the small business valuation methods and how are they different?
There are three primary approaches to small business valuation: asset, income and market based. However, there are a number of different methods under each approach.
Generally speaking, asset-based approaches don't work well for companies that are running in the black, but may be used in companies that are failing.
Adjusted Net Asset Value: This requires the appraiser adjust the company's assets and liabilities to fair market value.
Liquidation Value: When a company discontinues operations or restructures, the proceeds are calculated using the premise of an orderly or forced liquidation.
Book Value : Though it's sometimes used, this method has some flaws. It's based on accounting figures but often doesn't reflect the asset's actual value due to depreciation schedules.
Excess Earnings: This method combines asset and income based approaches by calculating earnings to measure intangible business assets as an extension or multiplier above a reasonable asset value.
An income-based approach has two methods depending on whether income is steady or inconsistent. The company's income over a period of time is multiplied to determine its overall value.
Capitalization of Earnings: When a steady income is the norm for a business, this method uses adjustments to normalize the income stream of a business for a single period, and then multiplies that benefit over a longer period of time.
Discounted Earnings: Also referred to as discounted cash flow, this takes an inconsistent or irregular income for a company and converts it to determine the current value of future income benefits for that company.
This type of approach uses current market conditions to determine the value of a business, whether based on income, a similar business or overall transactions.
Guideline Public Company: A similar publicly-traded company allows the appraiser uses the price investors paid for minority interests in that company and adjusts it to match the private company that's being appraised.
Guideline Company Transactions: A similar company that's closely held is used as a basis for the appraised company, with transactions analyzed and adjusted to match the appraised company.
Multiple of Discretionary Earnings: Financial statements from small companies are adjusted to represent an owner-operator. It compares adjusted earnings to create a valuation multiple.
Gross Revenue Multiple: This uses a comparable company and divides transaction price by that company's revenue to create a multiple of gross revenue.
By having a better understanding of small business valuation methods, you can gain an appreciation of what exactly your business appraisal means, how it was calculated and in what situations it may or may not apply. However, the appraisal you receive and work from is only as good as the appraiser who calculates it and prepares the report. Make sure that the appraiser you use has a solid certification in business appraisal as well as experience in your industry before hiring them for the job.