• There a several different types of buyers.
  • Each type will value businesses differently.
  • Business valuation is incredibly complex.
  • Business is not an exact science; they are based on many subjective decisions.
  • Business valuations can vary from appraiser to appraiser.

Basic Valuation Approaches

There are three fundamental approaches to valuing a business:
Market Approach

  • Works best in real estate due to few parameters.
  • Businesses have many number of moving parts.
  • Comparative sales have to be used with other valuation methods. 
  • Often not enough data to compare apples to apples. 

Income Approach

  • Most common for valuing private small businesses. 
  • Based on company revenues and earnings. 
  • Method #1 is Multiple of Discretionary Earnings (SDE) Method, where SDE is defined as the net operating income plus adjustments plus the owner’s salary. 
  • The multiple is the inverse of the capitalization rate (cap rate). 
  • Method #2 is discounted cash flows is based on reasonable projections (usually 5 years), and uses a discount rate (usually the cap rate plus rate of growth) to calculate the present value of the future cash flows.
Asset Approach

  • Asset approach is used when fair market value of assets represents most or all of the business value. 
  • The net tangible assets of the business comprise : the machinery, equipment, furniture and fixtures, etc. 
  • Used when the business is no longer a going concern, or losing money for a few years.

Valuation Method Depends on Buyer Type

Let’s look at the most likely valuation methods used by each buyer type:
Strategic Buyer

  • Typically large private or public companies. 
  • Strategic buyers are interested in the future synergies and not as concerned about past performance. 
  • The likely valuation method will be the discounted cash flow approach.
Sophisticated Financial Buyer

  • Typically small investment groups, private equity groups (PEGs) and small companies interested in growth by acquisition. 
  • Interest in both past performance and future opportunities for growth. 
  • The likely valuation methods will be multiples of earnings and discounted cash flow.

Lifestyle Buyer  

  • Looking to supply income, equity, and debt service from future cash flows. 
  • Will buy the future, but only pay for the past. 
  • The valuation method is multiple of seller discretionary earnings. 
  • For larger companies they may use the multiple of EBITDA.
Industry Buyer

  • Industry buyers are in your niche, you know them, and consider your company inferior. Typically bottom feeders trolling to buy on the cheap. 
  • Valuation method will be the asset approach. 
  • If this particular buyer is interested in buying your company (total assets plus goodwill), then seek professional help to even the playing field.

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