If you are valuing a business based on its income, a major part of the challenge is coming up with accurate discount and capitalization rates. These factors capture the company’s risk – and affect the accuracy of your business appraisal.
You can determine the discount rate appropriate for your business by using the well-known Build-Up Model.
Market and company-specific risk
While some elements, or risk premia, can be determined by observing the overall capital markets, you also need to assess your particular business risk profile. This additional element gives you the important component of the discount rate – the company-specific risk premium.
Ten-factor company specific risk assessment
ValuAdder business valuation software gives you a consistent way to evaluate your company specific risk. You can do so by assessing ten important risk factors:
- Business revenue growth prospects.
- Company’s financial risk. Debt-free firms have much lower risk of financial failure than heavily leveraged businesses.
- Operational risks. Consider the difficulty and costs associated with growing your business.
- Business profitability compared to its industry peers.
- Customer concentration. A business with many customers is less risky than a company that relies on a few large customers for most of its income.
- Product concentration. A rich, diverse product mix reduces business risk – and contributes to higher business value.
- Market concentration. Compare a business that sells into many different markets to a company whose market is limited.
- Competitive position. A company in a well-protected market niche is less risky than a firm exposed to large, well-funded competitors.
- Quality of management team. Experienced business managers tend to make good decisions that reduce risk and contribute to higher business valuation.
- Quality of staff. Long-term employees are a great business asset. Their skill and dedication are major value-creating factors in any company.
The number of business valuations involving private law practices has grown steadily in recent years. The two main types of situations calling for a law firm appraisal are these:
- Transactional such as the law practice sale, merger or spin-off.
- Legal controversy. The most common reason is divorce followed by partner disputes.
Given the rising volume of law firm valuations you may wonder: what are the methods best suited for private law practice appraisal?
Methods for law practice appraisal
Law firms are a prominent example of professional service companies. Given the relatively low levels of hard assets in a typical law practice, most valuations are generally done using a combination of market and income-based appraisal methods.
For smaller privately owned and operated law practices you can do market value comparisons based on the recent law practice selling prices. Such comparisons usually rely upon the valuation multiples that are based on the firm’s gross revenues.
This value assessment is then complemented by the income analysis using the well-known Multiple of Discretionary Earnings business valuation method.
For larger law firms, the preferred income-based valuation method is Discounted Cash Flow. This valuation technique focuses on the law practice cash flow given the acceptable level of investment risk which is represented by the discount rate.
This combination of the comparative market value analysis and discounted cash flow valuation is known as the First Chicago Method.
Law practice goodwill valuation
For established law firms the value of business goodwill may be a sizable part of the overall practice value. Consider using the highly respected Capitalized Excess Earnings method, also known as the Treasury Method. You can calculate the law practice goodwill based on the so-called excess earnings – those in excess of the fair return on the capital committed.
We put a lot of work into our business valuation products – so that you can stay ahead of the latest economic changes. If you need an accurate, defensible business appraisal, the latest release of ValuAdder 4.5 gives you the tools for the job:
- A set of business valuation methods based on all three approaches: Asset, Income, and Market.
- A streamlined way to start with your company’s financial statements, recast the historic financials, assess business risk, and calculate your business value.
- A powerful way to create the right price and terms for a business sale or purchase.
- A comprehensive Learning and Info Center and Handbook covering all aspects of valuing small businesses and professional practices.
What is new in ValuAdder 4.5
We have increased the coverage in ValuAdder business valuation Rules of Thumb to 420 industries! To do so, we have analyzed some 20,000 recent private business sales deals – to give you the most accurate market-based valuation multiples available.
For 2009, we have updated the discount and capitalization rate data – critical to accurate business risk assessment. This ensures that your income-based business valuation results match today’s market conditions precisely.
Market-based business valuation – based on latest market data
Determining your business value by direct comparison to similar private business sales is especially important today. ValuAdder gives you the up-to-date estimates of business value including the statistically derived business value range, average and median values – across each of the 420 industries covered.
You can search and view each Rule of Thumb by the business type description, its industry, as well as the SIC and NAICS codes.
Here are the latest industry additions:
- Fruit, vegetables and preserves manufacturing companies.
- Wineries and spirits manufacturing firms.
- Business form production and printing services.
- Synthetic resins and elastomer products manufacturers.
- Manufacturers of vitamins, health and nutrition products.
- Cosmetics, beauty and hair care product manufacturing firms.
- Paint, finish and coating materials manufacturers.
- Ambulance services.
- Television stations.
Of course, we have reviewed all other 410 industries included in the ValuAdder Rules of Thumb for the latest business pricing trends. Business values in these industries show significant changes in 2009 compared to a year ago:
- Auto parts and accessories manufacturers.
- Moving and storage companies.
- Electrical equipment and other industrial parts distributors.
- Hardware stores.
- Apparel retail.
- Furniture stores.
- Coffee shops.
- Office building, 5-day deli caffees.
- Ice cream parlors.
- Pizza parlors.
- Family restaurants.
- Sandwich shops.
- Cocktail, bar and pub establishments.
- Specialty retail such as gift stores and greeting card shops.
- Flower shops.
- Securities dealers and brokers.
- Insurance agencies.
- Real estate brokers.
- Property management companies.
- Advertising agencies.
- Cleaning services including maid and janitorial companies.
- Packing, shipping and mail box rental businesses.
- Auto repair shops.
- Dental practices, including general family and oral surgery clinics.
- Environmental, engineering and accounting firms.
Business valuation based on income – using the current discount and cap rates
ValuAdder features detailed worksheets that contain the latest information on the discount and capitalization rates. This helps you assess business risk accounting for the broad economic factors as well as the company specific risk. You can use your company’s financial statements to:
- Determine the available cash flow.
- Assess business risk.
- Prepare all the inputs you need for your business appraisal.
Appraise any business – and avoid costly mistakes
The adjustments you make on the worksheets are essential for an accurate business valuation. Applying business valuation methods to incorrect financial inputs is the biggest cause of mistakes.
Owners of small businesses tend to report financials that minimize taxable income. As a result, your business appraisal should focus on cash flow rather than net income. In fact, professional business appraisals use the discretionary cash flow or net cash flow as the basis of determining business value.
ValuAdder worksheets are designed to help you get through this important step quickly and efficiently – by making the adjusting addback changes.
Nothing discredits a business appraisal more than using discount and capitalization rates that fail to capture your business risk. ValuAdder helps you assess your company-specific risk using a set of key financial and operational factors.
Business Valuation using ValuAdder
Market-based business valuation techniques are often used to value professional architecture firms, classified under SIC code 8712 and NAICS 541330. Many business sales in this professional services industry are brokered by skilled business broker intermediaries. As a result, there are reliable business sale comparables data to value your architectural services company.
While you have a number of valuation multiples for business value calculation, some are more accurate than others when it comes to valuing the architecture firms.
Top valuation multiples for architecture firm appraisals
Our ranking of valuation multiples is based on the coefficient of variation that indicates the spread of business valuation multiples around the average. The smaller the coefficient, the smaller the spread of business value estimates you get.
Here is our list of valuation multiples arranged in the order of their accuracy:
- Business selling price to gross revenues or net sales.
- Business enterprise value (EV) to EBITDA.
- Business sale price to EBIT.
- Business sale price to Net Income.
- Business sale price to total business assets.
- Price to the book value of equity.
The first valuation multiple is the typical one used for pricing an architectural company for sale.
Market players tend to value architecture firms based on EBITDA and net sales
The coefficient of variation for the net sales-based valuation multiple is just under 0.5 which is 2.5 times less than the equity-based number. What this means is that most architecture firm sales are actually priced using the company net sales or EBITDA as the valuation basis.
Setting the right asking price for your business can make a big difference to the successful sale outcome and the time it takes to sell the company. While the average days on market is around 470 days, it can take over 2 years to sell an architecture firm.
Example – business valuation of an architecture firm using the multiples
Let’s consider a typical firm grossing around $600,000 in net sales and generating $200,000 in EBITDA profits in the most recent year.
Using the typical valuation multiples of 0.5 times the net sales and 2 times the EBITDA, gives us the following estimates of business value for the firm:
- Business value based on net sales: $300,000.
- Business value based on EBITDA: $400,000.
One way to reconcile the difference is to average the two results above. Applying the weights based on the accuracy of each value estimate, we get:
$300,000 x 0.52 + $400,000 x 0.48 = $348,414
The business value estimate covers the tangible assets, goodwill and other valuable intangibles such as client lists. Cash, receivables and company owned real estate are usually not included.
More on valuation multiples for architecture firms
Recent sales of architecture firms are an excellent source of valuation multiples. You can estimate your firm’s fair market value based on its gross revenues, net sales, profits, EBITDA, cash flow and assets.