Business Valuation Blog | Understanding Buying / Selling a Company

Business Valuation: Differing Reasons Will Dictate Methodology

Posted by Business Valuation Specialists LLC on Nov 20, 2023 7:30:00 AM

Business Appraisal Methodologies to calculate value

I hear the phrase “the value is the value” oftentimes when discussing appraisal work with those not familiar with the profession. With machinery and equipment appraisals, the primary differences in value are fairly straightforward. They tend to correlate to the approach you most heavily rely upon and the definition of value that's estimated. Fair Market Value - Installed will drive a considerably higher value than any type of liquidation premise.

With business appraisals, it goes even further. Liquidation value is typically not a factor assuming the company is ongoing; however, the specific reason why an appraisal is needed will dictate the appropriate methodology and approach that best fits that perspective.

For example, if the purpose is for an outright sale of the company in the open market, the appraiser might need to back out the on-hand cash and liabilities from the balance sheet given the likelihood that the seller will cash out the liquid assets and be obligated to settle the liabilities at closing.

If the purpose is for a minority share buy-out or buy-in, the business appraiser will need to consider applying lack of control discounts to the overall value of the business when calculating the percentage share associated with the transaction. In other words, if 100% of the business is worth $500,000, a 20% non-controlling share will be less than $100,000, given the minority investors’ lack of control.

Another example may be a divorce scenario, where the company is being valued as part of a contested or negotiated division of assets. There may be factors pertaining to the ongoing litigation or settlement that will need to be considered before finalizing the value.

From a methodology perspective, it is quite often that a business appraisal can be reasonably valued using more than one approach. How these differing conclusions are weighed will factor into the overall estimate of value.

There is always going to be a level of subjectivity with any appraisal. Opinions will differ, depending on the data that is relied upon, the methodologies ultimately utilized, and the experience of the appraiser, who needs to make reasonable decisions to conclude on value.

When you need a business appraisal, take the time early in the process to cover these topics so you understand the approach that will be taken and ensure the methodology fits the overall purpose driven by the larger transactional picture.

Tags: small business valuation methods, Business Valuation Methodologies

The 3 Approaches and Most Commonly Used Methods of Business Valuation

Posted by Business Valuation Specialists LLC on Aug 14, 2023 7:30:00 AM

methods and approaches to small business valuation

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.

Tags: Business Appraiser, certified appraisal, small business valuation methods, Business Valuation Methodologies

Approaches and Methodologies Considered When Appraising Your Business

Posted by Business Valuation Specialists LLC on Jan 3, 2022 7:00:00 AM

Business Valuation Appraisal Methodologies Appraiser

Business owners likely have particular ideas about the value of their company and how best to calculate it, given their experience and knowledge of their financial history, and understanding of the market and industry in which they operate. When you need to formally engage an experienced, certified business appraiser to value your company, it's important to understand the standard accepted approaches they consider and weigh during the process.

There are three approaches to business valuation, namely the Income Approach, the Market Approach, and the Asset Approach. Each of these methodologies can be broken down further and considered based on the type of business you own, available data to analyze, and the company’s current operational status. Here is a brief summary:

Income Approach

The income-based approach has two primary methods that take into account whether the business income is steady or inconsistent. Essentially, the company's income is measured over a period of time to determine its overall value. Under a “Capitalization of Earnings” approach, the appraiser will consider both historic and future income probability, based on a steady stream of revenue, and discount these streams to realize a net present value, while using appropriate rates of capitalization.

Under the “Discounted Future Earnings” approach, the appraiser will estimate value primarily from future income probability, or forecasts, over a fixed period of time, to a terminal value, and discount this back to the present

Market Approach

>The Market Approach determines business value where the subject company being appraised can be compared to available businesses traded in the public marketplace. Adjustments are made to better match the private business based on revenue and overall size.

These guidelines are either investor-driven or transactional, depending on the data available. For example, a similar publicly-traded company may have available the price investors paid for minority interests in that company. This can then be adjusted to match the subject private business profile.

Other methods which take components of both the income and market approach are the “Multiple of Discretionary Earnings” and “Gross Revenue Multiple” which consider the actual income of the business being appraised and apply a market-derived multiple to these earnings based on available public data.

Asset Approach

As a general rule, the asset approach is considered and primarily weighed when a business is operating at a loss or has shut down temporarily or permanently. The options available to the appraiser under this approach are as follows:

Adjusted Net Asset Value: Under this methodology, the appraiser will adjust the company's tangible assets based on an estimate of Fair Market Value, while taking into account existing liabilities.

Liquidation Value: If the business has permanently ceased operations, and a compulsion to sell the remaining assets is the only remaining option, the value of the assets is measured under an Orderly or Forced Liquidation premise.

Book Value: This method relies solely on the net book figures of the assets recorded on the company’s books, without adjusting to market or liquidation value. Given accounting depreciation methods are usually accelerated, this will likely lead to undervaluing the assets.

Excess Earnings: This method takes into account the historic earnings of the company and provides a broad way to measure intangible asset value as well as tangible, by estimating the goodwill of a business along with personal property, equipment, improvements buildings, and land. This is generally preferred for fully operational companies with a lot of tangible assets.

By gaining a better understanding of these valuation methods, you will be able to work together with your certified, experienced business appraiser, in a successful fashion, to properly appraise your company.

Tags: business appraisal, small business valuation services, business valuation methods, small business valuation methods, Business Valuation Methodologies

Business Valuation Methodologies: How They Differ in Appraisals

Posted by Business Valuation Specialists LLC on Apr 29, 2019 8:00:00 AM

business valuation methodologiesbusiness valuation methodologies

When you're considering determining the value of your business, you may hear the term business valuation methodologies. But what are they, how do they impact the final calculated value of your company and why is it important to know the differences between them? Here's a quick look at the most common valuation methodologies to help get you started.

What Are the Different Business Valuation Methodologies Used in Appraisal Practices?

Asset-Based Approaches

Asset-based approaches look at what a business already has in terms of tangible and intangible assets and liabilities. These assets are then used to help determine the value of the business.

  • Adjusted Net Asset Value Method - This requires the appraiser to adjust the company's assets and liabilities to their fair market value as of the valuation date. 
  • Liquidation Value Method - When a company is discontinuing operations or restructuring, the proceeds from liquidation are calculated using either an orderly or forced liquidation approach.
  • Book Value Method - Though sometimes used, this method has serious flaws. It's an accounting number based on the value of assets on the books, but when equipment is fully depreciated before it's put out of service, it doesn't reflect a realistic business value.
  • Excess Earnings Method - When a business has significant goodwill or intangible assets, this type of methodology is used to calculate earnings above a reasonable return on the business' tangible assets. 

Income-Based Approaches

Income-based approaches to valuation look at how much money the company has coming in. The appraiser uses that income and projected future growth to determine the company's value.

  • Capitalization of Earnings Method - When a company has a regular income, this method is used to convert the ongoing benefits of that business over an extended period of time to determine the overall business value.
  • Discounted Earnings Method, or Discounted Cash Flow Method - With the terms used interchangeably, this method is used to determine value when a company has irregular income, cash flow issues or inconsistent growth to determine future value.

Market-Based Approaches

Market-based valuation approaches look at similar businesses. The valuation specialist then makes adjustments to value to reflect the subject company's situation.

  • Guideline Public Company Method - Using financial data from publicly-traded companies, this methods uses the actual price investors pay for a minority interest in similar companies to the business being valued.
  • Guideline Company Transactions Method - When companies are closely held, this method is used by using the value of companies with similar characteristics, including industry, size, products, services and location, as well as transaction dates of sale.
  • Multiple of Discretionary Earnings Method - This method takes a similar company and divides the transaction value by discretionary earnings, at which point the subject company's discretionary earnings are multiplied by the same multiple that was calculated.
  • Gross Revenue Multiple Method - This method divides the transaction price by the company's revenue, then similar companies are researched to determine a multiple, which is then used with the subject company's revenue to calculate value. It doesn't account for profitability, however.

By understanding the different business valuation methodologies, you'll have a better grasp of exactly what an appraiser is referring to when they're calculating your business value. This provides you with a much better understanding of the process and calculations involved, making you a much more active participant in the process.

Tags: Business Valuation Methodologies