Business Valuation Blog | Understanding Buying / Selling a Company

When you are trying to determine the overall value of your business, a certified appraisal is a great place to start. If you are a business owner, and your company’s stock is not traded publicly, it is considered a privately held concern. There are a few distinct variances between private and public company valuation methodologies. Understanding the potential approaches the appraiser will take to value your private company while using data from public businesses, is important as you work with them to develop a realistic and supportable value.

When private businesses are appraised, there are a number of approaches that are considered. For the majority of ongoing enterprises, the income and market approaches are measured and weighed to ultimately determine the most accurate value for your company. When the market approach is utilized, the business may be compared to a similar public company, while making adjustments that look to match the public company as closely as possible. The income approach will review historic and current revenues and expenses, in an effort to reasonably discount cash flows over a future earnings period.

There are other, deeper approaches the appraiser will consider as well, within the market and income methodologies.

Under the market approach, there is both a “Guideline Public Company Method” and a “Guideline Company Transactions Method” used for private businesses.

The first option reviews financial data that is freely available from similar publicly traded businesses. It considers the actual price investors would pay for a minority interest in the public company as the basis for the valuation. The public businesses targeted for comparison are typically in the same industry and market as the private company, with a similar business model.

The second “transactions” method may be considered if a public company has recently been sold which closely fits the structure of the private company, within the same business sector. Financial data may not be available, however, details of the sales transaction can be reviewed and weighed in the appraisal effort. Under the income approach, the “Multiple of Discretionary Earnings Method” and “Gross Revenue Multiple Method” are the two most commonly used for private companies.

Within the first of these, if your business is simply too small to compare to a public entity under the market guideline methods, this alternate approach might be more applicable. It looks solely at financial statements and adjusted earnings by deducting discretionary expenses from the bottom line of the typical public company model to create a reasonable multiple of adjusted earnings, which is then applied to your private business’s adjusted earnings.

Under the second income method, the gross revenue of a typical public company in your market is considered to estimate a multiple, which is then applied to your private company's revenue, to determine value. This method doesn't consider profitability, which may be a factor that will affect the appraisal.

Engaging with a certified business appraiser will start the process of valuing your private company and all of the potential methodologies considered in the process. The results will assist you in the potential sale of your company, or offer support when considering refinancing, new investment, updating company practices, and adapting to new markets.

When a business valuation is conducted for your firm, its assets will be considered in the overall value. If your business appraiser determines that a strict asset approach is relevant to the overall analysis, they will look to understand the market value of tangible items such as cash, receivables, inventory, machinery & equipment, buildings, and land.

If your business is in an active and operational condition, the value of its intangible assets will also be considered. These can include domain names, patents, copyrights, licenses, customer lists, client relationships, non-compete agreements with prior employees, a trained workforce, guaranteed contracts, leaseholds, and general goodwill.

These intangible assets are generally more challenging to estimate value for, as they are not typically itemized on your balance sheet, and need to be reviewed separately to determine a reasonable approach to appraising. The business appraiser will want to review as much internal data as you can make available so they can consider these intangibles as part of the revenue that continues to drive the business. It’s reasonable to look to carve out a value for these intangible assets based on their particular impact on the overall value of the business. The appraiser can provide guidelines to assist in developing historical data and potential growth in the company as a way to measure this in a finite manner.

>As an example, certain contracts and existing client relationships can likely be attributed directly to consistent and tangible revenue the company has experienced over the years. A newly signed contract may open a pathway to future growth that can be measured based on the terms of the deal.

In summary, when completing a business appraisal under an asset approach, it is important to measure the value of all the assets in the company, both tangible and intangible, to gain a complete perspective of the overall value for your business. Working with your appraiser to develop reasonable measurements to value these assets, will result in a credible and reliable outcome.

There are different ways to perform business appraisals. Whether you're hoping to buy an established company and get into business for yourself or sell your company for a fair price, it's important to know the different approaches to valuing your business and which one is the most appropriate for your situation.

Pros and Cons of Market-Based Business Valuations

A market-based business appraisal makes sense for many industries. Consider the owner of a semiconductor manufacturer located in California who wants to sell the company and retire. If there are other businesses nearby, operating in the same or similar marketplace, a business appraiser can compare the subject business being sold with others like it, getting an idea of the market share and competitive advantage of the business.

A “Gross Revenue Multiple Method” may work in these cases. Under this method, the appraiser takes the transaction price and divides it by the revenue. They then find similar companies and determine a gross revenue multiple. This multiple is applied to the target company's revenue to roughly estimate a business value. This method is simple and quick, however, far less detailed than other appraisal methods, and often best for preliminary measurement purposes only.

Pros and Cons of Asset-Based Business Valuations

An asset approach estimates how much it would cost to build a similar business from scratch. In this type of valuation, the professional appraiser will estimate the total assets and liabilities of the business. Subtracting liabilities from assets, the appraiser will come up with a valuation.

This method works well for companies that have significant physical assets. However, companies that have intangible assets find that an asset-based method may not accurately reflect their worth. Consider the example of an innovative engineering firm. The imaginative engineers who come up with elegant solutions to problems are not captured as “added-value” in an asset-based approach. If the engineering company was sold to a new buyer, but the existing staff quit, much of the company's true value would be irretrievably lost.

Pros and Cons of Income-Based Business Valuations (The “Discounted Cash Flow” Method)

If your company has a stable earnings flow, then the “EBITDA”, (earnings before interest, taxes, depreciation, and amortization) can portray an accurate business valuation. Since this provides a snapshot of the business valuation at one point in time, it might not be the best method if earnings are projected to spike or if the company is experiencing a slow quarter.

If the business is going through an inconsistent period, the discounted cash flow method may work well. Here, the appraiser estimates the future benefits of the company, then converts them to present value to come up with a fair market value.

Ultimately, a certified, experienced appraiser can determine which method makes sense for any given company at a given point in time, and reasonably estimate the company’s value, while explaining the process to key investors and owners. Given all that is at stake when considering selling your business, it's critical to hire a certified business appraiser who understands your industry.