Business Valuation – An Introduction

Business Valuation – An Introduction

At the outset, let me state that business valuation is an art, not a science. Even though there are industry-standard calculations which are relied upon, you must have a firm grasp of the underlying valuation assumptions. Or else, the calculations may not reasonably reflect your business’ fair market value.
Capital raising success hinges on ability to negotiate appropriate values for your business. The amount of capital you raise is proportionate to the value assigned to your business. If you (assuming you are the founder) seek or intend to seek outside capital, it is imperative that you establish a value for your company.

When seeking outside capital, what you think your company is worth is mostly irrelevant. Rather, you must determine what your company is worth to the outside investors and what value would they assign to your business. One key term you will often encounter in this context is ‘fair market value’. Simply put, fair market value is essentially the price at which the business or an interest is exchanged between a willing buyer and a willing seller, both of whom are sufficiently informed of the pertinent facts and are not under any compulsion to buy or sell.

There are several approaches to business valuation mainly Discounted Cash Flow (DCF), Relative Valuation and Contingent Claim Valuation.

In Discounted Cashflow Valuation, your business value is more or less the present value of expected future cashflows from your business.

Relative Valuation estimates value by considering the pricing of comparable businesses with respect to a common variable like earnings, cashflows, book value, etc.

Contingent Claim Valuation utilises option-pricing models (there are several ones) to determine your business value that share the option characteristics.

As I have stated in the beginning, you must have a proper understanding of the underlying valuation assumptions. It is important to note that the basis of all valuation approaches is the assumption that markets are inherently inefficient and value assessments or pricing will be fallible. Another assumption is about how and when these purported inefficiencies will get corrected. If the markets were efficient, the market price is undoubtedly the best estimate of value.

As you establish a value for your business, it is advisable to keep the following in mind:
Values are dependent on the industry you are inYour industry values change over the course of timeThough valuations are based on your industry, they are adjusted for special factors unique to your business and/or your investorsPrivate company valuations will be influenced by their counterparts’ valuations in public listed markets
Assumption, Assumptions, Business Valuation, Business Value, Cash Flow, Cashflows, Comparable Businesses, Compulsion, Contingent Claim Valuation, Grasp, Option Characteristics, Option Pricing, Outset, Pertinent Facts, Present Value, Pricing Models, Relative Valuation, Success Hinges, Willing Buyer, Willing Seller

Print article This entry was posted by Free Grant Money on August 2, 2010 at 12:06 am, and is filed under Venture Capital.