Chapter 3 - Valuing the Privately Held Business
Jay Trien, Senior Partner, Trien Rosenberg
Trien Rosenberg
2002-08-02
Company owners should consider determining their business's value for reasons other than just keeping score or knowing the potential selling price. Other purposes include securing financing for business growth, dividing assets in a divorce, and estate tax planning. The process of determining your company's enterprise value will also identify the business's competitive advantages and disadvantages, information that you can use to improve company's operations and value.
Many ways to measure worth
Valuing a privately held business depends on many variables that mesh together in a complicated analysis that is both an art and a science. While there is no one right method to use, valuation professionals apply certain methods depending on the type of business, the methods typical to your industry and then a combination of those methods are applied and averaged with more or less weight assigned to methods based on their usefulness. Some of the commonly employed business valuation methods include:
Industry rule of thumb method. This "ballpark" method compiles statistics on a given type of business sold during a specified time period and then calculates an average of all the selling prices. The method works well for average-performing business, but not so well for those falling outside the average.
Book value method. This method is based on a business's accounting records, whereby liabilities are subtracted from tangible assets, such as inventories, equipment, and real estate. Variations of this method may be applied to make adjustments for intangible assets, such as patents owned or deferred financing costs, and various market factors not reflected on a financial statement that also affect a business's value.
Capitalized earnings method. While there are variations of this method, "capitalization" is essentially based on the expected return on investment. In effect, the valuator determines the rate of return for assuming the risk to operate a business, whereby the amount of risk is proportionate to the amount of return required. Then the business's earnings (based on the current or projected year or three-year historical average) are divided by the capitalization rate. The value of the business subsequently depends on the investment amount required to earn the desired rate of return.
Multiples method. There are two commonly used multiples methods. "Sales" multiples are based on a business's annual sales and an industry multiplier value. Often used to determine the valuation ceiling for a business, "profit" multiples are based on earnings before interest, taxes, depreciation and amortization (EDBIDA) and a market multiplier.
It's not paint by numbers
While these methods are useful, they still don't paint a complete picture. No valuation formula can account for every variable that comes into play, such as: company size, industry, customer base, growth potential, competitive positioning, product mix, technological capabilities, and management talent. Often a business's value to a particular buyer is in excess of all these valuation methods when there is an important synergetic value to that buyer. In the role of merger and acquisition advisor I have assisted business owners to identify and motivate a buyer to pay a premium price.
Call in the cavalry
Deciding to sell your business should always be subjected to a "go, no go" analysis.
For example: 1. Determine the investment income you can expect to earn on the after tax proceeds of a sale, verses 2. Calculating the current economic value to you of keeping the business.
We can help you to determine the minimum sales price you need to obtain for your company so the return on the invested after-tax proceeds of the sale will exceed the total of your current personal income and perks from the business plus your company's future increases in retained earnings, book value and enterprise value.