How To Value A Private Business
How to Value a Private Business
How to Value a Private Business
by Caroline Clayfield
Any professional business valuer, private equity analyst, broker or experienced company trader will tell you that valuing a business is more a 'black art' than exact science. Making an accurate valuation can be challenging for sellers and buyers, but both sides have several techniques at their disposal to help them make a sensible estimate.
The subjectivity of business valuation is perhaps the first thing to come to terms with when buying or selling a business. The outgoing business owner will no doubt value their company at a much higher price than the buyer, who has not invested years of hard work into it. Sellers will usually have an emotional attachment to their businesses and will benefit from taking a step back and looking at it with the eyes of a buyer to gain a more realistic view of its value.
What doesnt help matters is the lack of real information and the abundance of misinformation that is made available about comparative sales, which can often skew valuations. People are very interested in acquisition values, but very little accurate data is published on actual selling prices achieved resulting in inflated figures.
This leads us to one of the techniques used to value private businesses the comparables technique. This is all about gaining a better understanding of what a company could be worth by looking at other completed deals within the industry.
Certain industries often have their own rules of thumb that can be used to grade and value businesses in the sector. There is some limited information available through firms like Business Sale Report in the UK and Bizbuysell.com and Business Valuation Resources in the US. The latter offers information gleaned from a huge network of investment banks and business brokers and can provide some information on sold prices.
Although the comparables method is certainly one of the techniques that can be helpful when putting a value on a business, it is by no means the most effective. It must be combined with several other techniques to help establish a clearer picture. Businesses are, after all, one of a kind and cannot be compared to similar sales because, unlike selling a house or a car, there is rarely anything similar enough to help form an accurate idea of value.
Perhaps the most common method that buyers and sellers have used in valuing a company is the income multiple or profit multiplier method. This method involves establishing the net income of the business, taking into account tax and depreciation, and multiplying by a factor that is established by examining several other variables, including comparable sales.
Deciding what to base the multiple on is where the challenges really begin. Among the variables that are usually taken into account are the age of the business, the relationships with customers and suppliers, the condition of the firms assets, how the business will respond to the sale, the lease terms and the strength of existing contracts.
A downside to this technique is evident in economies or industries on the slide: it looks at the historical performance of the company and on historical multiples paid, rather than focusing on the future.
So arguably one of the best valuation methods to use in tough economic climates is one that does indeed focus on the future cash flows of the business rather than past performance. The Discounted Cash Flow (DCF) approach looks at today's value (at a given rate of return) of the accumulated profits of the business over a number of years added to the value of the business in today's terms if it were sold at the end of this period.
The main reason DCF is not more widely used is that its relatively difficult to apply. It relies on the preparation of a full financial model that takes into account the expected macro-economic climate, the regulatory and legal framework, the industry outlook and the competitor landscape.
However, aside from all of these valuation techniques, perhaps the most important thing to remember is that the valuation will also differ depending on the buyer. An unprofitable business with a strong brand and an established presence in the US could be worth much more to an Asian buyer looking to move into new markets, than it would be to a trade buyer from the local area, for example.
Valuing a business is indeed an art. Buyers will benefit from basing their valuation on what they have to gain from a deal. Sellers will receive much higher offers if they can market their business to those buyers who see value where others do not.
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