Archive for May, 2013

One of the key business valuation techniques is comparing your business to recent sales of similar companies. This relies on the valuation multiples derived from business selling prices and financial performance measures of the companies sold. Usually, these multiples are based on the business earnings or asset values, e.g. revenues, discretionary cash flow, EBIT or EBITDA, total business assets and the like.

So far so good. If your industry sector has plenty of recent business sales that are captured in public or private sources of data, you can get your market comps to do the comparison. The more business sales the better since you can develop a decent set of valuation multiples that are statistically reliable.

But what if your business is unique enough so the comparison is difficult or impossible because similar companies do not sell often or such sales go unreported?

Here are a couple of suggestions you can use:

  • Call similar businesses you know. Business owners may be aware of the likely prices.
  • Contact business brokers that specialize in your industry. Often they keep their own data and may be willing to advise you.
  • Check with an industry group. They may help you directly or refer you to a business consultant with the knowledge of the market place for your type of business.
  • Contact a vendor that sells equipment or supplies to companies like yours.

If none of these sources have the answer you are looking for, then the market comparison may not be a good approach to value your company. You can still come up with a good estimate of your business value by using the various methods based on the asset and income approaches. These types of valuations do not call for a market comparison. Instead, your valuation is based on the direct assessment of your company value.

Use all 3 approaches in your valuation

You have three approaches to value any business. If the market approach is unsuitable, you can focus on the asset and income methods to get the job done.

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Can a company value be established based on its gross receipts? In the language of business appraisal this question is addressed by the so-called market approach. Under this approach to valuation you are actually comparing your company to other similar businesses that have sold recently.

You can do such comparison by reviewing the business selling prices in relation to their gross receipts or revenues. The ratio is known as the gross revenue valuation multiple.

Once you have come up with the valuation multiples you can apply them directly to your company’s gross receipts figure to calculate the estimate of your business value.

When is the value derived from the company’s gross receipts a good indicator of what it is worth? Here are the typical situations when you may want to consider using this valuation technique:

  • Professional practice valuation
  • Valuation of a rapidly growing company that has not been managed for maximum profitability
  • Whenever changes are planned that are likely to alter the business costs considerably
  • As an initial valuation that can be refined at a later date
  • When the returns and discounts are not significant for the company

Business brokers often use gross receipts as the quick measure on which to base their initial valuation for business clients. This enables them to establish a ballpark number to start with and share with the owners. This number can then be revised as the business selling strategy takes shape.

Be prepared to defend your valuation based on gross receipts as you share your results with others. Investors and partners may question this number based on how they see the company’s profit potential.

In other words, you may need to revisit your business value figure by offering valuation based on the company’s earning potential or its asset base. To do so, you can resort to a number of valuation methods that are based on the business income and assets. In some instances, your results may surprise you and indicate business value that is considerably higher or lower than your figure based on the company’s gross receipts.

Business Valuation based on Gross Receipts

Businesses may have a wide range of intangible assets at their disposal. One important type of such assets that tend to increase in value over time is databases and subscription lists.

This is especially so if the lists are assembled one item at a time. Consider a customer database that grows as the business adds new customers. A customer list of 100 is worth less that 1,000; while a database with 10,000 customers is worth even more. Compiling the list of 10,000 customers is going to cost more than 1,000 or even 8,000. The reason is that such lists grow one item at a time and the costs of expanding the list are incurred at every step.

Valuing such databases is likely to be done two ways. One way is to estimate the cost of putting the list together as of the current date. On the other hand, you can assess future sales and profits less the costs of compiling the list. In either case the result is the database value to the business.

One important point is that such databases or lists have the potential to grow in value. As the number of customers in the list grows there is the potential for even greater list value.

So if the database grows continuously, assigning a value to it may give you a wrong answer. If the database is worth $10,000 now or $1 per customer in the list, then even a 30 year useful life would result in some $333 being written off each year.

If the database doubles in size in 3 years, its value may well be $20,000. Instead, the depreciation shows that the database list is worth $9,000 due to depreciation.

The depreciation may not reflect what is really going on. As the database grows, its value should grow. Instead, the depreciation makes this intangible asset look less valuable each year.

While some intangible assets may have a limited useful life and decline in value, others, as the example above shows, do just the opposite.

Valuation of business and its assets

Business intangible assets are usually included in the estimate of business value. One of the most challenging tasks is valuation of goodwill, another key intangible asset.

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