You can value the entire business and calculate its value which includes all of its assets. This brings up a question, do individual business assets have value on their own? The answer depends upon the reason for valuation.
Consider, as an example, a piece of machinery the business uses to produce its products. Chances are the machine can be sold to an equipment dealer for a certain sum. Thus, this asset has a market value and can be taken out of the production line to be sold.
This example points out two critical elements associated with asset values:
Note that the machine in our example above was both separable and marketable, thus its value could be easily determined. All you have to do is make a couple of calls to used equipment dealers to get an estimate of the fair market value.
Now let’s consider a rental agreement the company has signed, locking in attractive rental rates for a period of time. This is a valuable intangible asset as it puts a cap on an important business expense going forward. Is it valuable?
Asset business value depends on who values it
The answer is it depends on who is doing the valuation. For the current business owners, the rental agreement is definitely valuable. In fact, its value is determined by the amount of relief the company gets from paying higher rentals in the future.
On the other hand, the rental agreement may be non-transferable. So if the company came up for sale, the new owners would have to renegotiate the rental agreement and the new terms may not be nearly as attractive. If the business buyer values the company, the value of this non-transferable rental contract is zero.
This distinction is often missed by business people and financial advisers: for whom is the business value determined?
Once you answer this key question, you can address the elements of separability and marketability to figure out if the asset is worth anything on its own. A good example of non-separable business asset is trained and assembled workforce. If the company is sold, the expectation is the employees, at least some of them, will remain with the business. You can’t sell employment agreements on their own, so the workforce asset is not separable or marketable, at least not in a free market economy.
If the company owns an asset that can’t be transferred to another party, its market value can’t be established. Just like in the above example with the business premises rental, the value is limited to the current business ownership.
That being said, many business assets can be very valuable, i.e. they can be pulled out of the existing business operations and sold to someone else. Obvious examples are equipment and machinery. Other examples include intangible assets such as patents and trademarks.
You can value the patents by using the so called relief from royalty method. Basically, you estimate the typical royalty payments the company would have to make in order to license a comparable invention from an outside patent holder. The present value of the royalty payments needed would give you a fair estimate of what the patent is worth.
Asset replacement is another way to look at a business asset value. What would it cost the company to develop and put into use similar set of assets? Consider the costs and time needed to re-develop in-house software tools, or a set of procedures used to produce company’s products. You can discount these costs to the present time to estimate the value of such assets.
The takeaway on business asset valuation is this: while the entire company is usually assumed to be marketable and valuable on its own, the individual business assets may lack in one or both of these key value factors. When in doubt, always consider if the business assets have a real secondary market and can be offered for sale on their own. In addition, always ask for whom the value is determined.More on Valuation