ADJUSTED BOOK VALUE METHOD
The adjusted book value method is probably one of the most rudimentary means for valuing a business and its assets. It is a simple book value of the net worth of the assets of the business. It takes into account depreciation of assets over time and what remains on the business books that could be purchased in an asset sale. Because asset sales are treated differently than stock sales, this method is important to perform if for no other reason than fully understanding what your tax liability might be in the event of a business sale. An annual assessment of your business value via this method is also helpful for management to understand what the business is ultimately worth.
Hence, the assumption aspect of this type of valuation is open to large degrees of interpretation. In many cases, acquirers will want to baseline internal assumptions with their own assumptions for future growth and profitability. In other words, performing a discounted cash flow is great when you’re assumptions are undeniably accurate. If not, they’ll need to be justified within the spreadsheet and available for adjustment based on differences in interpretation.
CAPITALIZED ADJUSTED EARNINGS
It is customary to utilize business cash flows to help determine the value of any business. When it comes to an acquisition scenario, such cash flows generally need adjusting given that new management will most likely be required make changes to company management by either making hiring decisions or downgrading key employees. In the event of an acquisition of an entrepreneurial founded business, most of the adjustments end up being add backs for expenses the business owner tends to run through his/her business. Once add-backs have been taken into consideration, a weighted average of historical earnings is considered and discounted using a pre-determined discount rate. This method is helpful as a useful benchmark from previous periods, but is generally one of many determinants in the true value of a business and its operations.
DISCOUNTED CASH FLOW METHOD
Discounting expected future cash flows is considered one of the best methods for determining the value of a project, the opportunity of an investment or the time-considered payback of a acquisition opportunity. It uses the expected future cash flows and discounting them by the weighted-average-cost of capital (WACC) for the industry. Discounting future earnings is easy when you have an actual cost of capital pegged-down and have a fairly sure knowledge of the true future cash flows of a business. This process can actually be very difficult if the company isn’t large enough, doesn’t have a substantial track record and is in a new, uncharted business. Private company valuation in this way is difficult because it can be hard to fully grasp the true value of the WACC and the cash-flows represent expected future earnings on something that hasn’t yet occurred.
CASH FLOWS METHOD
This method comes at the cash flows from the other direction. Using an amortization table, this method assumes the valuation hinges off how much the cash flows can support given a particular interest rate. The interest rate generally used is derived from standard and reasonable market rates for financing of the business in question.
Another way to put this type of valuation is this: with the current and expected future cash flows, what type of debt load could I expect to be able to float?
GROSS MULTIPLIER METHOD
Differing industries have different assumptions on what drives the value for the particular business in question. Some industries value companies off varying benchmark industry multiples including gross profit, operating profit, earnings before interest and taxes, and earnings before interest, taxes, depreciation and amortization. Some industries actual value the business based on other non-monetary multiples such as number of subscribers, number of customers or some other metric. The important thing is to use the right benchmark “rule of thumb” to understand the true worth of a business in the eyes of competing and knowledgeable acquirers within the industry itself.
NPV BUSINESS VALUATION
Some of the best valuation methods involve a proper assessment of the current and potential cash flows the business regularly produces. The Net-Present Value or NPV method takes into account the weighted-average cost of the company’s capital and assumes predictable and consistent capital structure and tax rates looking into the future. Like other methods the NPV method also takes into account as much publicly-available information as possible to determine comps, company beta and current and expected growth rates. In performing such a valuation, we also take into account sensitivities for changes in interest rates, growth rates and other external factors. Doing so helps to provide a proper expected “range” for enterprise value of the business.
APV BUSINESS VALUATION
As another key standard in our valuation processes, we utilize the adjusted present value (APV) method to assess corporate value. Like the NPV method, the APV method utilizes adjusted cash flows. Unlike NPV method, the APV method is often considered a bit more representative of true value and is often more simple in its application. In cases of high debt, changing tax rates, consistent operating losses and changing capital structure the APV method can actually be more representative of core value. This methodology takes into account effective tax shields for debt and ongoing concerns and changes in capital structure over time.
COMPS & “RULES OF THUMB”
Using previous industry-specific transactions as a benchmark threshold in assessing business value can be extremely beneficial. For instance, previously completed deals in the same sector and on companies of the same size can help provide a “gut check” when values become skewed. For instance, some markets have traditionally valued businesses on the basis of clients while others baseline from a multiple of sales or EBITDA.
Market multiples and general “rules of thumb” help us to understand a particular business worth when taking it to market. This method is used in conjunction with calculating cash flows and discounting via the cost of capital and perhaps is the most widely recognized method for seeing value how the industry would see it.
VENTURE CAPITAL VALUATIONS
The VC method is most often used in the case of start-ups seeking venture capital. However, it can be an effective means of seeing value before it has been officially created. Discount rates in venture capital valuations are magnitudes larger than those provided to existing businesses. Most venture capitalists justify this given such ventures will often involve much larger amounts of risk. Certainly VC valuations involve more art than science, but in any “investment” business they can provide a key insight for investors and entrepreneurs, giving them a middle ground of agreement which includes assumptions for the trade-offs of risk and return.
