Performing a valuation on your existing business or a business that you are looking to acquire is no simple task. A plethora of factors must be taken into account in order to arrive at a meaningful valuation. That said, in this article we will review (in the most simplistic form) some of the most common ways small businesses are valuated.
An Asset-based valuation seeks to find the value of a business by taking a comprehensive look at the net value of a business’s assets. There are two types of valuation methods. First, is the “going concern asset-based approach” which, takes the assets of a company, and subtracts the liabilities. Thus, the value of the business is the net value of this calculation. Second, is the “liquidation asset-based approach”. In this method the value of a business comes from the net cash that would be acquired after all liabilities were paid off and the assets were all sold.
In the realm of small business, using an asset-based approach to value a business can be difficult. For example, when analyzing the value of a sole proprietorship there may be assets that are in the name of the owner. Thus, they must be removed from the valuation unless the owner agrees to sell these assets as a part of the business.
Earning Value Approaches
The Earning Value Approaches are founded in the idea that a business’s value lies in its ability to generate income in the future. Probably the most common earning value approach is the Capitalized Earnings approach.
In this approach a valuator takes the estimated net earnings of a business, normalizes and multiplies it by a capitalization factor. The capitalization factor is simply a rate of return that the purchaser could expect on another investment.
Another Earnings Value Approach is the Excess Earnings Method. In this approach a valuator takes the adjusted net worth of a business and adds in the value of any intangibles. One important thing to note, is that the value of the intangibles takes into consideration the opportunity cost an investor would incur if they were to invest their money elsewhere.
Market Value Approaches
Market value approaches to business valuations establish the value of your business by comparing your business to other businesses within your specified market that have recently been sold. This approach can be particularly difficult in the case of sole proprietorship because, they are privately held companies and finding information on similar entities can be somewhat of a challenge.
What is the best choice?
Although the earnings approach is one of the most common method used. However, using a combination of all or several of these techniques may be the fairest way to your selling price. Furthermore, if you are looking to set a selling price for your business the first thing you should do is hire a professional. They will be able to guide you through this process and make certain that you successfully sell your business.