The concept of “fair market value” is the cornerstone of business valuation theory. It is the highest price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.
There are three types of valuation reports (Comprehensive, Estimate, Calculation) which are distinguished by the valuator’s scope of review, the amount of disclosure provided, as well as the level of assurance being provided in the conclusion.
Comprehensive Valuation Report
A Comprehensive Valuation Report contains a conclusion as to the value of shares, assets or an interest in a business that is based on a comprehensive review and analysis of the business, its industry and all other relevant factors, adequately corroborated and generally set out in a detailed valuation report.
Estimate Valuation Report
An Estimate Valuation Report contains a conclusion as to the value of shares, assets or an interest in a business that is based on limited review, analysis and corroboration of relevant information and is set out in a less detailed valuation report.
Calculation Valuation Report
A Calculation Valuation Report contains a conclusion as to the value of shares, assets or an interest in a business that is based on minimal review and analysis economic and little or no corroboration of relevant information, and generally set out in a brief valuation report.
There are three basic generally-accepted approaches to valuing a business which include the income approach, asset approach and market approach. The value of the business will vary based on the type of company, approach adopted, timing and risk associated with the business, industry, and investment. Valuation requires objectivity and independence.
Valuators typically use the following income-based methods as a primary approach:
The capitalization of maintainable earnings method involves dividing after-tax normalized earnings from operations by a capitalization rate (or alternatively, multiplying the after-tax normalized earnings from operations by a multiple derived from the capitalization rate). This method may be appropriate for:
The capitalization of maintainable cash flows method has many of the same conceptual and mechanical aspects as the capitalization of earnings method. However, the cash flow method has certain refinements, as the valuator concentrates on cash inflows and outlays rather than accounting-based earnings. The use of a cash flow-based method rather than an accounting earnings-based valuation method is generally preferable where any of the following conditions exist:
The discounted cash flow method involves estimating future net discretionary cash flow on a year-by-year basis and discounting the cash flow estimates to their present value using an appropriate rate of return. In other words, the discounted cash flow approach is a present value calculation of the future cash flows expected to accrue to a given business interest.
Asset-based techniques calculate a value based solely on the value of the net assets of the
business without consideration of its future earnings capacity. The asset-based approach can be used for valuing both businesses which are going concerns and those which are not. However, the approach is used differently depending on whether or not the business is a going concern.
Asset-based techniques include:
The adjusted net book value technique involves adjusting the business’ tangible assets and liabilities to their current fair market values with the resultant net equity representing the going concern value of the business.
The liquidation approach is appropriate where:
Tangible asset backing is the value of the operating assets minus operating liabilities of a business. Thus, tangible asset backing does not include redundant assets or debt. Tangible asset backing (TAB) is not a primary valuation technique but rather it is generally used in conjunction with an income-based technique (e.g., capitalized earnings or cash flows) to assess risk. The value of the operating assets when calculating TAB is based on a going-concern assumption.
A market approach that typically assumes a going-concern premise, comparable company multiples can provide insight into value, and may also be used for corroborative purposes against that of other valuation approaches as well.
Comparable company empirical data can be found in market-based valuation ratios of comparable companies that are engaged in the same or similar lines of business, and that are actively traded on a free and open market. Market approaches based on comparable company information can also provide objective, empirical data for developing valuation ratios for use in business valuation.
Considering comparable data about other companies — when it is adequate and relevant — can be a very useful tool in the valuation of businesses, business ownership interests and/or securities.
They can be classified into the following approaches:
Multiples based on open market transactions (that are not based on stock exchange trading prices), whether public or private. The evaluator can use these market multiples as:
The cost of a business valuation depends on the valuator’s time and expenses. Factors include:
It takes many hours to compile information, fully analyze a company, develop a financial forecast, apply valuation methods within each required approach and make a final determination of value, and prepare a comprehensive valuation report.
When appropriate, I can provide limited scope value calculations for much lower cost. The appropriate level of service and fees can usually be determined after an initial contact.
A business valuation worth relying on requires thorough and careful analysis. Thus, a reliable valuation will take some time. Among other things, the time required will depend on the purpose of the valuation as well as the availability of information. A business valuation prepared by a competent professional will generally require 20 to 40 hours of the expert’s time (and sometimes more), but a consultation or calculation assignment may require significantly less.
Generally, once the valuator has received all the requested information, a reasonable expectation for delivery of the report is between 30 and 45 days. However, engagements requiring a quicker turn-around can sometimes be arranged.