To the uninitiated it may come as a surprise: there are a number of proven methods you can use to value a business in any industry.
It puzzles some business people. After all, they say, my business is unique. And valuing it may differ from valuation of companies that are vastly different. Right? Well, yes and no.
Standard business valuation methods work for any company
Business appraisal standards include the renowned Uniform Standards of Professional Appraisal Practice (USPAP), the more recent AICPA Statement on Standards for Valuation Services (SSVS No 1), and International Valuation Standards (IVS). And all of them discuss the common methods and approaches you can use to value a business in any industry. That’s right, no matter how unique your company is, its economic value can be measured by applying a number of standard yardsticks. Moreover, all these methods fall under the three broad approaches to business valuation: Asset, Income, and Market.
This unifying framework gives you the power to systematically value businesses and compare valuation results across a wide range of conditions inherent in specific industries.
While surprising at first, a closer look at the fundamentals reveals why such valuation framework works. The methods pose the same universal questions about the value creating factors and their effect on business value.
Valuation methods focus on the fundamentals that apply to all businesses
All operating companies have assets, both tangible and intangible. The values of such assets are one indicator of what a company is worth.
On the other hand, an investor may look at any company as an income producing investment. Then the value of such an investment is measured based on the company’s ability to generate returns at an acceptable level of risk. Enter the income based valuation methods.
Finally, pretty much all real world businesses compete against their peers and share a number of value creating attributes. This enables meaningful comparisons across your industry sector to figure out your business value. You can do this based on established valuations of your competitors, especially if business sales numbers are known. This is the foundation of the market approach and its ubiquitous valuation multiples by industry.
Universal methods to value companies with unique sets of value drivers
Yet it is undoubtedly true that each business is unique. How do you apply the standard valuation methods and still capture the factors that build your company’s value? In short, by carefully analyzing your company’s specific strengths, weaknesses, and risks. And then working up specific inputs for your business valuation calculations.
As an example, let’s say you run a pharma company that has developed a new drug awaiting the FDA approval. If the approval comes early, you can start selling your new products and dominate the market in the short term. In valuing your business under this happy scenario, you would create the earnings forecast that captures the expected sales growth. Competition is going to take a while to catch up and your selling prices will reflect that. Higher business earnings and lower competitive risks will result in higher business value. You can easily calculate this result by using the standard discounted cash flow valuation method.
Now imagine a less rosy scenario where your company fails to get the early FDA approval. Back to the drawing board, more R&D, double blind studies, proof of patient safety and the like. Time is ticking, your competitors are given a chance to narrow the gap. Guess what? Your earnings forecast and increased risk will feed into a lower business valuation result. Again, you can capture the difference using the same discounted cash flow valuation.
Same business valuation methods, different assumptions
The takeaway is this: the same business valuation methods can be used to measure values of companies in any industry sectors. What you need to do is carefully consider the opportunities and risks facing your company going forward. Then create the appropriate earnings forecasts, assess business risk, and feed your assumptions into your valuation calculations.