Which Valuation Method to Use
The reality is that there is no golden rule or formula which applies in every instance when you are trying to place a value on a business, no magic multiple that can be applied to arrive at the correct value, or algorithm that can be designed to mathematically calculate the value. Ultimately the business value equals the highest price the buyer is willing to pay and the lowest price the seller is willing to accept. In truth, finding the correct business valuation has always been partly science and also partly an art form. The combination of both in connection with utilizing several valuation methodologies, taking into consideration all the tangible and in-tangible factors, will assist you in arriving at an appropriate valuation range. Several of the more common methods used to triangulate the value are described here.
Asset-based valuation is a straightforward method in which the value of the business is determined by the total value of the company’s tangible and intangible assets. This method is challenged in that asset-based valuations often over-simplify the process and neglect the value of the company’s earnings potential.
Earningsmultiplier method is considered a solid way to assign value. It utilizes the business’s earnings potential as the measure to fairly estimate the purchase price and provides a basis for a buyer to project a return on investment (ROI). This method includes reviewing a business’s financials and developing an understanding of the client base and future growth prospects.
Comparable sales or market method is thought to provide the most recent form of value estimator because it reflects actual market activity for the type of business. It includes those businesses sold or up for sale, but presents a challenge because no two businesses are the same. Even if they appear to be similar in terms of industry or products and services sold, they never are identical. This approach is often used as a guide to be further refined by other valuation methods.
Utilizing these quantitative analyzes as a starting point, there are many factors which drive a valuation to increase or decrease, including:
- The current seller’s situation (e.g., objectives, timeline, etc.)
- The length of time the business has been operating
- The flexibility in the seller’s terms
- The local competition and/or recent changes in the marketplace
- The riskiness of the business (e.g., key client risk)
- The client and/or supplier contracts
- The debt of the business and other financial obligations
- Any pending legal actions
Developing the right valuation is possible with careful analysis and consideration of the multiple impacting factors. Using the services of a professional advisor can greatly improve your chances for reaching the appropriate value.
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