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Understanding Value

What is Your Business Worth? What you see is not usually, what you get.

Business Owners have important reasons to know the value of their business as a business is the most valuable possession that an individual can have.

For understanding a business value, one must differentiate between price and value.

PRICE: It is the amount that a buyer agrees to pay and a seller agrees to accept in circumstances surrounding their transaction.

Asking Price: It is the amount what the seller wants.

Selling Price: Total consideration specified in an Agreement of Purchase and Sale, paid by the buyer to the seller in exchange for the ownership in a business/ assets or it is the amount what seller gets.

Value: It is a measure of determining the worth/ fair market value of a Business.

Fair Market Value: It is the highest price the buyer is willing to pay and the lowest price the seller is willing to accept.

Going concern value: It the value of an established, ongoing business operation in premises that will continue its operation in future.

VALUATION

It is the process of determining the fair market value of a business. Valuations are highly subjective calculations to determine fair market value of a business. The valuation is time specific, there is no negotiation, and there is no exposure to the open market.

Business Valuation Approaches

We are discussing here generally used ways of determining the value of small and mid-sized businesses. There are three broad business valuation approaches in these days. Used for small business valuation. Each approach provides foundation for a group of methods used to determine the company value.

Market Approach

In this approach, the business value is established in comparison to historic sales involving similar businesses.

  • Use: The market approach is probably more suited to valuing public companies where good amount of comparable data is available to do the job.  For small and mid-sized businesses the comparable enough data is not readily, available so can only be used in conjunction with other valuation methods.

Income Approach

In this approach, the value is determined based on the business ability to generate economic benefits (revenues and earnings) for the owners. One of the methods used in this approach is multiple of Seller Discretionary Earnings (SDE) method. SDE is net operating income plus adjustments, plus owner’s salary. Another method used is Discounted Cash Flows, which is based on realistic projections using a discount rate to calculate the present value of the future cash flow. The discount rate is usually the cap rate plus rate of growth.

  • Use: Widely used for valuing privately held small and mid-sized businesses

Asset Approach

In this approach the value is determined based on the value of the business net tangible assets e.g. the machinery, equipment, furniture and fixtures, etc.

  • Use: It is used typically when the business is no longer a going concern, or if the business has been losing money for the last few years.

Acquirer Type and Valuation Method

Valuing a business is different for each type of acquirer. One acquirer may see a business as worthless while another is willing to pay millions for the same! Value is dependent upon types of Buyers. The Value of a Business is the amount of Opportunity a Buyer Perceives in it.

The Strategic Acquirer and Valuation Methods

Strategic buyers are typically large private corporations or public companies, they traditionally pay very high prices, and virtually always pay cash! Typically you will find that they are either public companies or very large private corporations.

Business of Interest:  Interested in a firm that fit the following acquisition criteria:

  • Sales in excess of $20 million
  • Proprietary process or product
  • Suitable levels of management in place
  • Unique market presence or share
  • Synergistic fit with acquirer’s goals
  • Management willing to stay

Method of Valuation: Their most likely valuation method will be the discounted cash flow approach.

Sophisticated or Corporate Acquirer and Valuation Methods

This is a new and expanding buyer segment. Many casual observers fail to recognize this group. Their numbers have increased dramatically. These are small investment groups, private equity groups (PEGs) and small companies interested in acquisitions for growth. These buyers are interested in what target company has done in the past as well as opportunities for growth in the future.

Business of Interest:

  • Manufacture or distribution
  • Proprietary process or product
  • Niche market or have a specific industry preference
  • Prefer management remain or stay for significant transition period

Method of Valuation: Their most likely valuation methods will be the various multiples of earnings using EBIT and EBITDA and the discounted cash flow approach.

Financial or Lifestyle Buyer and Valuation Methods

Financial and Lifestyle buyers are large in number. They tend to focus solely on the present and past. They will attribute any improvement in profits to their own efforts and will not pay prices based upon projections.

Business of Interest:  They will consider a price fair if the transaction can meet three criteria:

  1. This group does not pay all cash. They expect terms or the ability to finance the purchase.
  2. They consider a modest return on their cash into the deal as not being unreasonable.
  3. They have families to feed so minimum living wages are expected from the business upon purchase. A wage commensurate with their initial investment is usually considered fair.

This group is primarily interested in purchasing a job. They will not buy unless they can see a FIT and the potential for making the business better.

Method of Valuation: Their valuation methods of choice is the multiple of seller discretionary earnings (SDE). For larger companies in this group may use the multiple of EBITDA method.

Industry Buyer and Valuation Methods

Industry Buyers can be either the “best” or the “worst” buyers. Many times they are the buyers of last resort. They are the best buyers when they have a strategic reasons to buy. Most industry buyers look only to selected assets to determine value.

Business of Interest:  The industry buyer is usually somebody in your niche that you may know. They do not want to pay for goodwill.

Method of Valuation: If they use a valuation method, it will be the asset approach – probably a book value method.

 

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