There are a number of circumstances which may require the need to determine the market value of a business. Certainly, buying and selling a business is the most common reason. Estate planning, re-organisation, partnership splits or verification of net worth for lenders or investors, are other reasons.
Determining a fair market value is not a precise science, and can vary depending on the type of business and the reason for a request of a valuation appraisal. There are a wide range of factors to consider – from the book value of the assets, to a host of intangible elements. In general, the value of the business will rely on an analysis of the company’s cash flow, its past and current earnings, and the sustainability of those earnings. In other words, its ability to generate consistent profits will ultimately determine its worth in the “marketplace”.
Through the entity of LINK Corporate Division, we have a focus on acquisition, divestment and facilitation of the sale of private companies, which has resulted in sale prices of between $500,000 and $20 million. Over the past few years, we have facilitated the sale of over 200 businesses with sale prices in excess of $1 million.
The comprehensive database at LINK and the statistical evidence derived there-from, together with our involvement with various industry statistical databases, indicates the value of those businesses with sound profitable history by using an “industry” multiplier - the PE (Price to Earnings) Ratio. This multiplier fluctuates and is market sector driven.
However, whilst earnings history is key to most business valuations, the PE Ratio may not necessarily be the best indicator of value. Strong, but under-performing assets and revenue strengths, where price to sales will have an influence on the methodology used, can be equally important.
An industry specific formula has been devised by LINK, based on the “real world” out there in the market. Most business valuation methodologies should recognise market evidence and industry specific practice.
Basically, there are 3 business valuation approaches:
- Earnings based
- Asset based
- Market based
All three are considered in our valuation appraisal & opinion approach. A fair market approach based on industry experience and comparable sales may well be the most accurate indicator of value.
Pricing a Business
At LINK we have recognised the need for a new style of business valuation service, one that is based on “real market” rationale, and one which is easily read and understood by non accountants. We use market-driven techniques because we have the day to day experience with which to back up those opinions. We emphasis that most business valuation methodologies should recognise market evidence and practice, and our approach will certainly do so.
However, methodology used will be cognisant of Advisory Engagement Standard No.2 (AES-2) as set down by the Institute of Chartered Accountants and covering independent business valuation engagements.
In general, differing methodologies will be applied depending on the size of the business, and remember that as a rule, small businesses make up over 95% of all businesses. Statistical evidence and market data derived from actual sales within the marketplace may be the most accurate indicator of value.
The Valuation Appraisal Opinion
Our opinion on the total value of the business is usually given on a Going Concern basis, with sustainability of earnings based on the historical and current earning capacity of the business, (i.e. willing, informed but cautious buyer’s expectations of the ability of the business to maintain profitability for a foreseeable period of time).
A complete report relative to all aspects of the business inclusive of the financial documentation supplied, the business culture and infrastructure and its relevance to its market sector. In particular, an assessment of risk factors peculiar to the specific business and the market within which it trades.
With the increasing emphasis on earnings rather than assets, the applied PE Ratio is of significance, because of the effect that it will have on the return on investment.
Therefore our opinion on Business Value will be directly related to:
- The “industry average” multiplier on true earnings. We emphasise that this multiplier is market driven and varies according to perceived industry risk factors, perceived earnings sustainability and historical comparisons.
- The fair market value of the unencumbered assets of the business (e.g. plant, fixtures, fittings, equipment and in certain cases the value of debtors) = the value of stock at historical cost.
- Goodwill/ Intangible Assets
Because of the intangible nature of Goodwill and the various factors that comprise this asset, the valuation method adopted will depend on the circumstances of each particular business. No one method can be used for every business as each business has its own specific characteristics with regard to mix of tangible and intangible assets. We understand and can provide the market evidence of required rates of return (ROI) for business investments with various degrees of risk.