Which business valuation methods are best?
Of all the valuation methods out there, which ones are the best? The answer is it depends.
If you need a sure fire prescription for an accurate, defensible business valuation, reach out for the business valuation methods the professional appraisers use.
Each method has its own strengths and weaknesses. Because it reveals your business value in a slightly different light.
Valuing a business requires that you carefully analyze the company across a number of economic fundamentals. For instance, professional business appraisers handle business valuation in three ways they call approaches:
Use several valuation methods together
Pick a number of proven valuation methods under each approach. This gives you a solid view of business value from all angles. In fact, all professional business appraisal standards, such as the Uniform Standards of Professional Appraisal Practice (USPAP), require that you use methods covering each valuation approach.
For instance, the asset-based methods such as the Asset Accumulation or Capitalized Excess Earnings, help you figure out the company’s value based on the market values of its assets.
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. Yet 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 these method choices, which ones should you pick? This depends on your specific situation. Some suggestions:
Start-up valuation – assess its future potential
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. As a result, you should focus on the income-based valuation method choices.
One of the best ones is the Discounted Cash Flow method. Use it to calculate your business value based on your earnings forecasts. Moreover, you can re-run the valuation for a number of such forecasts, each with its own risk profile represented by the appropriate discount rate.
Valuation of a cash cow company – it’s about the stream of earnings
Established firms that tend to generate reliable, steady income streams are very desirable. As a result, sales of such businesses abound. And this gives you plenty of business sale comparable data to make an accurate market value assessment.
Direct capitalization methods, such as the Capitalized Earnings and 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. This makes the business an institution in its market place which creates considerable goodwill. So 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 of small, successful companies are common. As a result, market based business valuation methods work very well for valuing such firms.
The Multiple of Discretionary Earnings method is a good choice here. Why? Because you can figure out the business value based on a number of financial, operational and lifestyle factors, not just earnings.
Professional practice valuation
Professional practices are a special type of service firms. Most importantly, they tend to create a lot of business goodwill. So 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.