A Business Appraisal relies on three broadly accepted approaches that consider all the potential variables that factor into a valuation: The Income Approach, Market Approach, and Asset Approach.
These approaches review and analyze historic performance, reasonable growth projections, and the underlying assets of a company to estimate value. Depending on the circumstances, one or all three will be weighed in the final assessment.
Within these three approaches, there are a multitude of methods by which business value can be measured, however, when appraising a small privately owned company, there are typically only three methods utilized. Here is a brief summary of each:
The Capitalization of Earnings Method under the Income Approach
This method looks at the future projected growth of a business where historic revenues can reasonably predict ongoing trends over the next few years. Future cash flows are discounted back to the present date of the appraisal to establish value on a current basis. This method is most appropriate when a small business has shown a relatively steady level of revenue and income over the last 3-5+ years.
The Direct Merger and Acquisition Method under the Market Approach
This method estimates the prices paid for closely held companies that are in a similar line of business and can be considered comparable. Based on the data available in the market, it develops multiples that can be applied to the gross revenue and discretionary earnings of the business being appraised.
The Adjusted Net Asset Method under the Asset Approach
This method reviews all the tangible assets in the company, including real property, equipment, F&E, and inventory. Estimates are ideally based on an assessment of market value, or if that is not available, net book value. It also factors in cash, receivables, and liabilities to realize a net asset value. This method can be applicable if a business is capital-intensive but not producing a lot of revenue or net income, while also being appropriate for a company that is winding down operations.
In summary, you can discuss these methods in more detail with a certified valuation professional to better qualify which approach would likely apply to your small business. Taking the steps necessary to understand these approaches and methods before committing to a business appraisal will help you avoid any unexpected surprises.