There are many reasons that a business valuation may be required. Below we listed our top 3 ones:
Business valuation will inform business owners where their business stands in their specific industry or market relative to the competition. This information is an important tool in deciding on strategic matters such as a financing, sale, merger or an acquisition.
A valuation analysis helps to determine the important factors in the business that influence the outcome of the valuation. Identifying these value drivers helps owners make smart choices to enhance the value of their business. For instance, having a sense of the true value of your business can guide owners in deciding when is the perfect time to market their business or new products. Moreover, a valuation will establish which products, services or clients are most profitable and must be kept, invested in or alternatively dropped.
There are myriad reasons related to financial and tax reporting requirements which make a business valuation required or even mandatory. Some of the main ones include:
The principles of business valuations are applied by using three general valuation approaches:
The income approach forecasts and measures the future anticipated income that a business can generate and quantifies the present value of such income. This approach requires analyses of variables that drive income, such as revenues, operating expenses and taxes. Models application of this approach is usually done by a Discounted Cash Flow (DCF) analysis or Capitalization of Cash Flow (CCF).
The market approach is determining the value of a business by inferring from the selling or trading metrics of comparable businesses and applying these metrics to the business’ own metrics. Application of this method is typically done by “Trading Comparables” – comparing a business to a list of similar companies that are publicly traded – and by “Precedent Acquisitions” – comparing the business to a list of recently acquired companies. In both methods the goal is to learn at what multiples of relevant financial metrics (revenue, EBITDA, earnings etc.) are similar companies currently trading at or recently bought at, and apply these multiples to the valued business’ metrics. For example: if similar companies are traded, on average, at a market value that equals 8x times their EBITDA, then taking the business which we want to value and multiple its EBITDA by 8x would give the fair market value of the business.
The asset-based approach encompasses a set of methods that value the company by reference to its balance sheet. In contrast, income approach and market approach valuation methods primarily focus on the company’s income statement and/or cash flow statement. The goal of this approach is to value (and not the recorded balance of) all of the assets and all of the liabilities of the subject company. Application of this the asset-based approach is based on a defined value for the subject assets. And, the defined value (whatever standard of value applies) is usually based on the expected sale price of the subject asset over a defined period of time, between some defined parties.
Our discounted cash flow model (“DCF model”) is the main model used in applying the income approach to valuation. This model values a company by forecasting its’ future economic interests (cash flows) and discounting them using a discount rate to arrive at a current, present value. The discount rate is the company’s weighted average cost of capital (WACC).
Our LBO model is designed to evaluate if a business is suitable for a leverage buyout – i.e. the acquisition of it using a significant amount of debt. The goal of this model is to determine if an investment is worth pursuing by calculating the expected internal rate of return (IRR) given a debt to equity ratio (typically 70-30%). The more debt the target company can service, the more attractive LBO opportunity it becomes and the higher the IRR is to the investors.
Our comparable trading multiples (Comps) model analyzes publicly traded companies similar to the subject valuation company by identifying such companies in the same or similar industry, with similar operating and financial profiles. The model extrapolates the financial statistics from the peer companies onto the subject valuation business. The main concept is that the subject valuation business will be valued by the market the same way the peer group is being valued.
Very similar to the trading comps, the acquisition comps model (also knows as “M&A Comps”, “Comparable Transactions,” or “Precedent Transactions”) looks into the valuation statistics in recent market transactions where similar companies have been acquired. In such transactions, the purchasing company typically pay a control premium— over the market value of the company. Thus, Acquisition Comps model will typically result in higher valuations than in a general Trading Comps Analysis.
The goal of merger analysis is to determine if the price paid to a firm (seller) by another firm (buyer) is accretive or dilutive to the buyer’s earnings per share. This model combines the income statements for the buyer and seller, adds revenue synergies and cost savings (if any), adjusts for any interest foregone (if purchase price is paid all or part in cash) and accounts for any the shares issued in the transaction. The ultimate goal of this analysis is to compare the new combined earnings per share to the buyer’s standalone earnings per share and see whether or not the deal is accretive or dilutive.
Early-stage businesses are often very difficult to value based on the traditional methodologies due often to fact that startups have little to no past financials to account for to predict the longer term outcome. When appraising such companies, we apply specific valuation methodologies to arrvie at the fair market value of the business, such as the VC Method or the Barkus Method. To learn more about our valuation of startups click here.
