TaxConnections has recently received permission to post a series of articles from the book Business Valuation, Growing Value And Liquidity Realization written by Michael Gilburd. Over the past several decades, Michael has prepared valuations and assisted in debt and equity placements from tens of thousands to millions and hundreds of millions of dollars while working for major financial companies.
Introduction – Business Valuation, Growing Value And Liquidity Realization
Business Owners and Business Buyers: What’s the Right Value?
Most business owners have very little confidence in their own abilities to set market values for their most important assets. According to the International Business Brokers Association, most business owners simply don’t know where to turn for reliable advice in a buy or sell situation. Some turn to lawyers or accountants, others turn to stockbrokers or even friends, but the truth is that without formal training and industry standard modeling techniques, none of these professionals is qualified to set valuations on businesses of any kind. The key to protecting your assets and interests at any bargaining table is to know that your position is supported by leading edge methodologies executed with seasoned valuation expertise.
What is your business worth?
As your business grows, you will face an important question: What is it really worth? Determining the value of a business is hardly pure science. To assess its value, an appraiser must consider many factors, including:
• The overall health of the business as demonstrated by its assets, liabilities, cash flow and earning capacity
• Marketplace conditions, including competition and consumer demand
• Future events, such as new products or potential lawsuits
• Intangible factors such as customer mix and loyalty, brand awareness, company know-how and employee morale
In any business valuation, the most important factor is the premise of value – your reason for seeking the valuation. There are many reasons for having a business appraised, each of which might result in a different valuation:
• Sale of the business or a partial interest
• Purchase of a business
• Allocation of assets
• Buy-sell agreement between owners
• Estate planning
• Succession planning
In most cases the value of your business will vary depending on the reason the appraisal is being performed. For example, if you were selling a stake in your business, you might want to determine the fair market value of the business – what it would fetch on the open market. However, if you wanted to insure your business assets, you would seek to determine its insurable value.
What is a Business Valuation?
A business valuation determines the estimated market value of a business entity. A valuation estimates the complex economic benefits that arise from combining a group of physical assets with a group of intangible assets of the business as a going concern.
The valuation, which is part art and part science, estimates the price that hypothetical informed buyers and sellers would negotiate at arm’s length for an entire business or a partial equity interest.
Fair Market Value will be determined for your entire company or a percentage interest, as of the date you select, and for the purpose you specify. Fair Market Value is defined as the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. A Business Appraiser will determine the Fair Market Value of Your Company assuming its existence as an ongoing business. This premise of value is usually only applicable for the stated purpose, and the results should not be used for any other purpose.
Three general approaches are considered in analyzing the value of your business. These three approaches are inter-related and are often referred to as the Income, Market and Asset-Based approaches. Each of these general approaches is comprised of numerous variations, or methods. The selection of a given approach is based on the facts and circumstances of your company and the availability of required information. A Business Appraiser will ascertain value using a combination of certain approaches, methods, or variations of same.
1. In the Market Approach, the value of a business is estimated by comparing your company to similar businesses whose ownership interests are actively traded in public markets or which have been recently sold. Also included in this category are indications of value derived from transactions of entire companies, transactions in the shares of your company, or acquisitions made by your company. This is applied as the price per unit of a measure of financial performance or position. This equates to a multiple approach, using price-to-earnings or similar market/transaction derived factors applied against the appropriate financial measure generated by your business to indicate value.
2. The Income Approach has several variants. One of these is the Discounted Cash Flow Approach. In the discounted cash flow approach, the cash flows anticipated over several periods, plus a terminal value as of the end of that time horizon, are discounted to their present value using an appropriate rate of return. The discounted cash flow analysis and other prospective models are considered to be the most theoretically correct approaches because they explicitly evaluate the future benefits associated with owning the business. Other income approaches are based on capitalizing some measure of financial performance, such as Capitalization of Earnings or Capitalization of Dividends, using a capitalization rate commensurate with both the risk and long-term growth prospects of your company.
3. The Asset-Based Approach involves comparing the net asset book value to an estimate of the fair market value of all assets, and then subtracting the estimated fair market value of all liabilities.
Selection And Weighing Of Methods
The selection of and reliance on appropriate methods and procedures depends on the judgment of the Business Appraiser ̶ not on any prescribed formula. One or more approaches may not be relevant to a particular situation, and more than one method under an approach may be relevant.
The Business Appraiser uses informed judgment when determining the relative weight to be accorded to indications of value reached on the basis of various methods, or whether an indication of value from a single method should dominate. The Business Appraiser’s judgment may be presented either in general terms or in terms of mathematical weighting of the indicated values reflected in the conclusion. In any case, the appraiser should provide the rationale for the selection or weighing of the method or methods relied on in reaching the conclusion.
Written By Michael Gilburd (Part I)