Inital Valuation

Once an owner has decided time is right to sell the company, the first question is generally how much? The first step in the process should be to analyze and to calculate a full, fair market and justifiable business valuation. 

There are several generally acceptable valuation techniques, all which, by and large, can be categorized as one of, or as some combination and/or variation of three general methods.

  • Asset Cost Base method, which is based on replacement cost, or fair market value of included assets.
  • Income or Earnings Based method, which looks at the present value of future earnings.
  • Market Comparison method, which estimates the value of one business by the comparative valuation of others.

In our view, the first two are most applicable to the valuation of small closely held businesses. In our view, the value of a small business is typically that amount which is equal to the value of its balance sheet plus the value of its goodwill, which is a calculation that combines elements of cost based and of earnings based methods.

Balance Sheet Value is simply the net of assets minus liabilities included in the sale. Assets are usually valued at book value in a share sale, or at fair market value in an asset sale, and liabilities at book value. Balance Sheet Value is a relatively simple and non-controversial calculation that represents retained earnings from the company’s past business. Balance Sheet Value is a reasonably known entity.

Goodwill Value is not so known, but based on the anticipation (estimation) of the future earnings that can be sustained out of the market presence here-to-fore established by the company. Goodwill valuation means to place a value on those sustainable earnings, which will be typically calculated on a multiple of *normalized ebitda. (*which means earnings before interest, taxes, depreciation, amortization, which are then normalized also to before extraordinary or non-business, non-essential and non-recurring income, costs and expenses.)

Cash Flow set the limits. Ultimately, the business will be expected to pay (repay) for itself over a reasonable period of time following the sale. Discretionary cash flow available from normalized ebitda will impose a regulator on the valuation, based on what the cash flow can support, service and repay over that reasonable return period.

This Initial Valuation should establish the method and manner in which selling price is established and in which valuation will be maintained (updated) throughout the time it takes to sell the business. In an on-going business, value will be incrementally changed literally with every business transaction. To capture the accumulation of such changes, valuation should be updated just prior to an offer to purchase, and then again just prior to the close of sale, which we will talk more about later.

Business Valuations and ValuPro are more thoroughly described in the Business Valuations section and in the ValuPro section.  Briefly however, in analyzing and in the calculation of such business valuation, we typically use a valuation program called ValuPro, which is a program developed by davidsonashe, inc.  In our descriptions of the valuation and presentation processes, we will refer to ValuPro from time to time because it employs the techniques and methods we deem most suited to the occasion and because it provides us with ready example and illustration.

ValuPro is designed to calculate a fair market value of a viable on-going business on the strength of its balance sheet, on the sustainability of its earnings and on the ability of a business to pay for itself over a reasonable period of time. ValuPro is also designed to generate a series of business profiles or business-for-sale presentation packages.

ValuPro is not designed to calculate the value of a ‘start-up’ or any business without earnings, unless earnings can be credibly forecast, which is often a tall order, but there may be times, such as in a new franchise perhaps. Otherwise, no earnings are apt to mean no goodwill value and apt to limit the value of the business to simply the value of assets alone.

There may indeed be business potentials; maybe some startups, inventions, good ideas, buy-a-job, however, where there will be real but non-calculable intangible value, value that may be evident only to the eye of the beholder, ...still, those are not the business valuations ValuPro was designed to calculate.