Each day, our Business Valuation practice fields inquiries from business owners seeking a valuation of their company. Almost as often, they want to know exactly how we go about determining value.
We typically respond with an explanation of the three traditional approaches to completing a business valuation – Cost, Market, and Income.
The Cost Approach is a way of determining value that is based on the assets and liabilities of the subject company. In theory, the value of the company is equal to (no less than) the value of its assets minus its liabilities. This relates to the cost it would take to replace the same assemblage of assets.
The Market Approach uses comparative pricing to ascertain the value of a subject company. Similar companies may have been bought or sold (in their entireties or just publicly-traded shares); if transaction pricing and financial results are available, then we can apply these metrics to determine a value for our subject company. For example, if a similar company with $100 in sales was sold for $60, then the transaction reflected a pricing of 0.6x sales – which can be applied to the sales of the subject company to impute value.
The Income Approach is based on the financial theory that the value of a security is equal to the present value of its future benefits, typically viewed as cash flows discounted at a rate that reflects inherent risk therein. This Approach utilizes a projection of operating results developed specifically for the company with input from management.
Of course, all of this is highly intuitive. The value of an asset should be related to the cost to replace it; the prices of very similar assets; and the benefits to be realized from it.
In valuing YOUR business however, all of these approaches are not equally relevant or appropriate (though all must be considered). I recently spoke to a government contractor seeking a business valuation; she wanted to make sure we would use a Market Approach. I assured her that we would, but also pointed out that the value of a government contractor is highly related to the type and size of its contract backlog. Accordingly, an Income Approach based on company-specific projections might be even more important than more generic market-based multiples that do not incorporate the company’s contract backlog.
While the theory behind business valuation is fairly intuitive, the application of appropriate methodology requires experience and judgment. Our Business Valuation practice group would be glad to discuss your valuation needs.
Have questions? Evergreen’s team of business valuation professionals work with many of the Baltimore and Washington area’s top attorneys and financial planners, providing their clients with the necessary business valuation support. We welcome confidential consultations – Give us a call today.