The answer depends on your situation.
If you need a recipe for an accurate, defensible business valuation make sure you choose a number of professionally accepted business valuation methods to do it.
Valuing a business requires that you carefully analyze the company across a number of economic fundamentals. Professional business appraisers approach business valuation in three ways:
- Asset approach
- Income approach
- Market approach
Selecting and applying a number of proven valuation methods under each approach gives you a comprehensive view of the business value.
The income valuation methods let you estimate the value of the company based on its earning capacity and risk. On the other hand, the market based appraisal methods focus on comparison of your business to similar firms that have sold recently.
All these methods take a different view of what drives business value. No one method is better than the other. That is why selecting a number of valuation methods is the best way to create a sound business valuation.
Given all the method choices, which ones should you pick? This depends on your specific business situation. Here are some suggestions:
Valuing a young company presents unique challenges. Since most comparable business sales involve established firms, it makes little sense to use the market-based valuation methods.
Asset based valuation methods focus on establishing the value of the business based on a proven, optimized asset base. Often, business goodwill is a large part of business value, especially for businesses in the service industry. Yet it takes time to build goodwill in a business.
A start-up’s value depends on its potential to generate future earnings at an acceptable risk. This leaves you with the income-based valuation method choices. One of the best ones is the Discounted Cash Flow method. You can calculate your business value based on a number of earnings forecasts, each with its own risk profile represented by the appropriate discount rate.
Business valuation of an established cash cow company
Established firms that tend to generate reliable, steady income streams are very desirable. As a result, they are frequent acquisition targets. This gives you plenty of business sale comparables data to make an accurate business market value assessment.
Direct capitalization methods, such as the Multiple of Discretionary Earnings method, are an excellent choice for valuing companies with stable, recurring earnings.
Steady earnings tend to be associated with a large, loyal customer base. The business becomes an institution in its market place which creates considerable goodwill. You can use the famous Treasury Method to calculate the value of business goodwill and total company value.
Valuing an owner-operator managed small business
If your business operates in the service, retail or wholesale industries, comparable business sales abound for small, successful companies. Market based business valuation methods work very well in valuing such firms.
The Multiple of Discretionary Earnings method is a very common choice under the income approach. In addition to the business earnings, the method lets you determine the business value based on a number of financial, operational and lifestyle factors.
Professional practice valuation
Professional practices are a special type of service firms. Perhaps the biggest difference is that they tend to create considerable business goodwill. If you need to appraise a medical or dental practice or an accounting firm, the Capitalized Excess Earnings method should be high on your list.
For larger practices the Discounted Cash Flow method is the typical choice. On the other hand, you can value a single practitioner firm using the Multiple of Discretionary Earnings method.