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BUSINESS ASSETS TRUST

Determining Value of the Business

Overview

It is helpful to view the firm from many perspectives to gain a greater understanding of value. This is especially true for owner/managers who often find it very difficult to accept that a potential buyer have a justifiably different opinion on value of the firm without being overly pessimistic regarding its prospects.

Most investeors look primarily at Sales, Contracts, Services, Inventory, Experience, Staff, Products, Cash on Hand, Laws, Licenses, just to name a few.

Think like an Investor

The price is important. So is the down payment, and other costs of acquisition. The terms, the rate of return, and ultimately the ability of a positive cash flow are most important.

Rational investors engage in investments that are expected to create wealth. Wealth is created when realized returns exceed expected returns. You may be perfectly content to earn a 10% percent return on your equity capital, but other investors in the industry, or related industries, may consider a 10% return insufficient for the level of risk in your business. Therefore, for investment purposes they will expect higher rates of return. In order to have a realistic chance at earning those higher returns the potential buyers or investors will place a lower value on your business than you do. Investors want to be paid for the risk they are taking. You should too.

Value Estimation and Forecasting

Recall that when we are thinking like investors we are considering the size, timing, and uncertainty of future cash flows. Because every acceptable valuation method relies on expectations of the future, they are necessarily dependent on estimation and forecasting.
    The following list contains those that are frequently used:
  1. - Book value of equity (accounting estimate of value)
  2. - Market value per share (market estimate of value)
  3. - Discounted cash flows (theoretical estimate of value)
  4. - Option values (theoretical estimate of value)
  5. - Replacement values (market estimate of value of similar assets)
  6. - Liquidation values (market-based estimate of value of similar assets)
  7. - Guideline company multiples (market estimate of value of similar firms)
  8. - Guideline transactions multiples (acquirer’s estimate of value of similar firms)

What Valuation is Not

It is tempting for owners to find quick and inexpensive ways to estimate the values of their companies. For example, an owner may have an accountant or another trusted professional advise them on the going rate for firms like their own. The advice may take a form such as “just use one times revenues to find the value of your company” or some other rule of thumb. This approach, while inexpensive and easy to use and understand, has little hope of helping an owner arrive at a fair or reasonable value for his or her company. Finally, the valuation process is not intended to arrive at some pre-determined value through manipulation of the methods and estimators that are employed. Rather, the process is intended to guide an appraiser through the application of valuation theory, reasonable estimators and assumptions, and judgment and experience in order to arrive at a reasonable and credible valuation outcome.