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Business Valuation

How Valuations Are Derived

There are many different firms offering business valuation services — including CPA's. There are only a few, though, that offer you the quality of service and the track record to make the valuation worthwhile.

A valuation from a Certified Valuator reflects the "Fair Market Value" of a business based on recast assets, cash flows, the company history and potential, the economy and industry sector and business values in today's market.

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business valuation #1

What It's Worth

Determining Value of a Business

Getting the true market value of a company is best obtained by using a fully qualified and experienced business valuation specialist to prepare a market valuation assessment of the following:

  • company assets
  • location
  • economic strength
  • market position
  • goodwill
  • and other factors

Without it, the buyer and seller will likely end up in long, tedious negotiations that can delay the closing of a sale and may leave a significant amount of value on the table.

Book Value vs. Market Value

Many business owners use tax returns or financial statements prepared for tax returns as a basis of determining value. Tax returns reflect an understatement of "True Value" because they report depreciated assets and IRS deductions.

In addition, the business goodwill or name, which represents the market value of the company, is not a consideration for tax purposes and is often not reflected. What you have is a "book value" that is lower than the true "market value" of the business.

Determining the Right Valuation Method

The professional valuation professionals we have within our network can provide the following types of valuation reports:

  • 1: Executive Summary:
    Summarizes the qualitative information of the company - the history - the market - and other pertinent information.
  • The valuer will only consider limited relevant information and will perform only a limited analysis. This type of report is generally used by smaller companies.
  • (The first two are complimentary reports with zero cost and no obligation)
  • A limited review of business risk factors is performed and the competitive environment is examined, and there is an abbreviated company description.
  • This is the most common report to support a business sale and the results are often used to support the pre-approval of a business for Commercial financing, thus limiting your need to hold a Seller's Note!
  • A comprehensive review of the business risk factors is undertaken, a detailed description of the company and its positioning is provided, and a review and assessment of the prevailing economic conditions in the specific industry is undertaken.
  • (Usually requested and needed for public sales, estate planning and legal split agreements. You need a detail valuation to support the numbers.)

Certified Business Valuation Services

CFOne has within our network qualified and credentialed Business Valuation Experts who can determine a true business value and present it in a high quality professional report.

Contact us for more information to determine which valuation best serves your purposes.

Krayton M Davis
Executive Director, CFOne Business Advisory Services
Serving Richmond and Northern VA
1-571-306-3590

or e-mail your inquiry to:
info@cfone.com

 

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business valuation #2

Valuation Methods

Doing a Quick Value Assessment

Use this simple but non-substantiated business valuation formula to value and price your business:

Pricing Formula:
Take the value of your assets minus your account receivables (the value should be after you have re-casted your financials)

Formula:
Sum(1) = asset value - current acct receivables

Add your net asset value to your 1-Yr. cash flow (use the most recent year's cash flow position)

Formula:
Sum(2) = Sum(1) + one year's cash flow

Now take the cash flow and multiply it by 3

Formula:
Sum(3) = one year's cash flow x 3

Add Sum(2) and Sum(3):

Formula:
Sum(4) = (net asset value + cash flow) + (cash flow x 3)

Divide Sum(4) by 2

Add in the value of the accounts receivables

Formula:
Sum(5) = (Sum(4) / 2) + (Accounts Receivables)

This will give you an approximate value of the business.

See calculation example

Setting Price by Weighted-Cash Flow

This is a common practice used in the industry to get an estimated company valuation. It is based on the weighted cash flow position of the company over a 2-yr, 3-yr or 5-yr average.

You simply "weight" the current and prior year cash flow position to derive the company's overall cash flow that is multiplied by an industry multiple to derive overall value.

Pricing Formula

Formula 2-Yr Avg:
Cash Flow = (2021 cash flow*2 + 2020 cash flow*1)/3

Formula 3-Yr Avg:
Cash Flow = (2021 cash flow*3 + 2020 cash flow*2 + 2019 cash flow*1)/6

Formula 5-Yr Avg:
Cash Flow = (2021 cash flow*5 + 2020 cash flow*4 + 2019 cash flow*3 + 2018 cash flow *2 + 2017 cash flow *1)/15

Find the industry multiple

Formula:
the industry multiple is determined by similar companies that have sold or that are currently on the market

Take the cash flow average and multiply it by an industry multiple

Formula:
Sum(2) = weighted cash flow (X) industry multiple

See calculation example

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business valuation #3

Other Price Settings

that can determine overall value

Understand that there is NO magic formula for setting price. Price is calculated with this one rule in mind:

Price is set at what the buyer will pay — it is not derived from any mathematical equation but rather as a psychological perception by the buyer.

If the buyer perceives that the value of business is great, they will pay a higher price. That is why you should target your selling strategy to those buyers who will perceive your offering at a greater value.

Setting Price Market Strength - Technology

If your business has intrinsic value such as goodwill, established contractual relationships, prime location, or proprietary technology, you may set a value that equates the cost it would take for the buyer to replicate that value.

For example:
if you have proprietary technology that would cost the buyer $YYY in development and time, the value of that technology would be priced at $YYY+ if the technology can be used in the going operations of the business.

If your business has contractual relationships that would take a buyer $ZZZ dollars to develop, the value of those relationships would be worth $ZZZ+ if those contracts can be transferred to the new buyer.

Setting these values can be tricky. We highly recommend that you use a professional valuation based on:

  1. Income Based Approach
    measures the present worth of anticipated future net cash flows
  2. Market Comparison Approach
    compares recent transactions of similar businesses that have been sold

    see what your company is worth: contact us for details on a valuation choice

Setting Price by Asset Holdings

Asset valuation is less complex than market valuation. You simply price the company based on the replacement or liquidation value of your company assets and equipment.

If you have specialized equipment that is not easily compared in value with other readily available equipment, you might consider a professional valuation based on:

  1. Asset Based Approach
    considers the replacement cost as an indicator of value. This will substantiate the asking price for your asset holdings

    see what your company is worth: contact us for details on a valuation choice

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business valuation #5

To Whom To Sell

pricing strategies for those looking to buy

The value of a company can be perceived differently depending on the type of buyer. It is critical to market your business sale to the right buyer.

Buyers Looking for Assets

  • these buyers are only interested in purchasing equipment or assets that can compliment their current operations
  • they will be shopping equipment at bargain prices
  • they may have little or no interest in your markets or goodwill
  • Pricing Formula:
    the price they will pay is the market value of your equipment and assets - which is generally priced at its replacement value
    use this pricing strategy when you want to exit the business
    target the sale of your business to the competition or other-like businesses in your area

Buyers Looking to Buy Location

  • there are buyers who are interested in a particular location such as a retail intersection or logistical handling (i.e., next to the airport).
  • these buyers may or may not be interested in your assets, goodwill, or markets
  • sellers in this situation generally own the building and land
  • these buyers will either tear down or renovate your existing location
  • Pricing Formula:
    the perceived value is dependent on the macro-changes that are happening or expected to happen for that location
    the price they will pay depends on retail price of similar property in the surrounding area
    understand the potential use of your location. If your location is in a prime retail location for example, you may price your business and land at a premium
    you should get an independent land appraisal to substantiate your price

Buyers Looking to Buy Your Established Market or Operation

  • the seller will have established contracts/sales in a geographic location or market to a demographic group where the sales barriers are high
  • the buyer will have interest to move into an established market and ramp up their business quickly
  • Pricing Formula:
    the buyer's perceived value is dependent on the cost and time to establish a similar market or operation
    if the barriers of entry are high, meaning that the cost to setup and capture a similar market relationships are high, then your price could be somewhat high
    if the cost to setup a similar market is not high, then your price will be dependent on the buyer's perceived value of timing - how quickly they want to be in the market.
    understand the cost to setup a similar market. If that cost is high, then the perceived value may be high depending on your projected market position
    if the cost to establish a similar market is not high, then the perceived value is the strength of your documented cash flow position

Buyers Looking to Buy Your Technology

  • the seller will have a specialized or patented technology that cannot be replicated within a reasonable time or cost
  • the buyer will be an established operation that can benefit from this technology
  • Pricing Formula:
    in most cases, the buyer would seek to license the technology and may not be interested in buying your operations
    the buyer's perceived value is the opportunity cost of not having the technology
    price the business and technology together with the technology piece the greater portion of the overall value
    the buyer may perceive the value as a great buy where they can take ownership of the technology and discontinue you as a potential hostage holder or competitor

Buyers Looking to Buy Your Goodwill

  • the seller will have a strong brand name in a defined market.
  • the buyer will want to capitalize on the brand name to expand their marketing operations
  • Pricing Formula:
    the perceived value is dependent on strength of the brand name and the current operations or product line
    the value will depend on the brand - which can be subject to different opinions - and the value of your assets and earnings
    if you are in a position of strength - meaning that your cash flow position and brand recognition are strong - you can bump the price up.

Buyers Looking to Own Their Business

  • the seller has a business that is performing well with potential growth opportunities
  • the buyer will be an individual who left the corporate ranks to look for an independent business opportunity
  • Pricing Formula:
    the buyer's perceived value is the cost to finance the business, set an annual salary for the themselves or another business manager, and maintain required capital expenditures
    the higher your cash flow position, the greater your market value
    price will be based on your cash flow position which can be 2-3 times over cash flow

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business valuation #5

How Others See Value

the value must be agreed to by 3rd parties

The pricing point from the buyer's position is whether the cash flow from the business will justify the purchase price for the business.

Company Valuation Using Cash-Asset Position

Measuring Cash:

Take the:

company's discretionary cash flow
use a 3-year or 5-year weighted average: see calculations

 

Reduce this by:

Annual debt service
this will include the principal and interest payments for financing the purchase price of the business less the down payment

Owner or manager annual salary
the market rate for managing the business either as the owner or through a hired manager

Capital Expenditures
the amount that must be paid to maintain, service, and replace business equipment and other fixed assets. A good benchmark is to replace all operating assets within five years. Take the market value of the operating assets and divide by 5

Return on Down Payment
the investment return on the down payment

 

Equals:

Remaining Cash Flow
this amount needs to be positive to justify the asking price.

What the Lender May See

The lender is interested in two things:

  1. Does the historical cash flow (and projected cash flow) cover the cost of financing with a 20-25% cushion in the event of economic or market turn-down?
  2. If in the event of a default, can the bank recover the financing by selling the company assets?

If the answer is "no" to question 1, the lender will not finance the deal.

If the answer is "no" to question 2, the lender may finance the deal if you (via the buyer) can demonstrate that the business is a growing entity that support increasing cash flow.

  • Lenders assume a lot of risk when financing business purchases. Their only security in the event of default is the operating and fixed assets.
  • Lenders will not lend on goodwill and brand equity only. They are looking for a business that has been managed well, has a management plan in place to grow the business, and has a history of financials that support the projected earnings expected.

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business valuation #6

Some Will Not Sell

many businesses that are listed do not sell

3 out of 4 Businesses That Are Listed for Sale Will Not Sell

... or will not get the price that what to achieve. It is more difficult to sell a business than real estate. Comparing real estate to another location making it relatively easy to determine and compare value.

There are 1MILLION Realtors all sharing information about properties for sale, all ready to split their commission with other Realtors to ensure the property is sold. That exposure all but assures you that your property will be seen by people interested in and able to make a purchase.

This is not true for a business. The facts about a business, especially a privately owned business are hidden from view and held in confidentiality. This information is ONLY provided to a prospective buyer when the buyer has been qualified to make a buy transaction.

Certified Business Valuation Services

CFOne has within our network qualified and credentialed Business Valuation Experts who can determine a true business value and present it in a high quality professional report.

Contact us for more information to determine which valuation best serves your purposes.

Krayton M Davis
Executive Director, CFOne Business Advisory Services
Serving Richmond and Northern VA
1-571-306-3590

or e-mail your inquiry to:
info@cfone.com

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Krayton M Davis
Executive Director, CFOne Business Advisory Services
Serving Richmond and Northern VA
1-571-306-3590

or e-mail your inquiry to:
info@cfone.com

 

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