Earlier this month, we explored the unique ways in which the Covid-19 pandemic – and it’s government-related business assistance – now question the true valuation of a company. In the wake of today’s scandal related news, where the co-founder of a venture-backed startup has been charged with inflating the company’s revenue to convince investors to value the business at over $1 billion-we want to circle back to the importance of valuing your business.
Fortunately, the company in this case has not been charged in the scandal, but the abundance of less covered incidents are occurring all over the country. Here at MCDA CCG, Inc., we strongly recommend that you regularly update your valuations as you would your financial documents.
What is a Business valuation?
A business valuation is the general process of determining the current economic value of a whole business or company unit. The valuation of a business is used by several different parties including investors, creditors, sellers, and buyers interested in a company. Accurately calculating business value requires effort through complex calculations and an enlightened perspective. Like a home appraisal, someone is going to inspect and analyze a business in order to determine its value
Common Methods of Valuation
There are numerous ways a company can be valued. You’ll learn about several of these methods below.
Asset-Based Valuation Methods
As implied by the name, this approach focuses on the valuation of a company’s assets, where it emphasizes total assets and liabilities. To identify the current equity value of a company, one subtracts the market value of any debt held by the company. Determining the valuation may also require adjustment for the intangible assets of the firm that may be incapable of replacement. Asset-based valuation has many variables based upon the purpose or type of company being valued. Common asset-based valuations include:
- Book Value
- Replacement Value
- Liquidation Value
Market-based Valuation Approaches
With this approach, a business is valued based upon its productivity in a specific market. These methods focus on comparisons of competitors, transactions, or industries. Most of these methods focus on identifying a value-based, characteristic of the comparable and comparing it to the total price or value of the firm. The ratio of this value-based characteristic to price is used to value businesses with similar productive output, involved in similar transactions (the reason for valuation), or operating within the same industry. In summary, these methods attribute a value to a business by using ratios (value characteristic to price) to compare the firm being valued with other firms whose value is readily determined.
Income-Based Valuation Approaches
Income based approaches value a business based upon the past, current, or expected future cash flows of the business and the risk that the business will not produce the desired return. Estimating and valuing flows of income is done through a process called capitalization. Capitalizing the income streams will produce a so-called present value. Risk is incorporated into this valuation through a discounting process. An applicable valuation formula will discount the present value of cash flows based upon the probability that the firm will not achieve the desired cash flows in the future. The discount rate uses many factors relevant to the individual firm that make the firm’s projections more or less likely. Below are multiple income-based valuation approaches:
- Earnings Capitalization
- Build-Up Method
- Discounted Cash Flow Method
- Excess Earnings Method
- Economic Value Added Methods
Which Approach is right for my business?
While the above are the most common methods to business valuations, the diversity of companies and their varying factors remove the “one size fits all” approach. For most businesses, using a combination of business valuing methods will be the fairest way to identify a price.
Hybrid Methods of Valuation
Numerous hybrid methods exist for valuing a business given the situation or scenario. For example:
Venture Capital Methods – This method combines market-based multiples and discounts on projected cash flows for the business.
First Chicago Method – This method uses the venture capital method and employs an averaging function among multiple VC method valuations.
Options-Based Methods – These methods employ complicated mathematical models to value a business based upon the options that exist for the use of money.
The first step in determining the value of your company: hire a professional with the adept knowledge to advise you throughout this complicated journey.
Even if you feel exceptionally well rehearsed in business valuations, constantly changing market conditions stress the importance of turning this process over to someone with a successful track record. Here at MCDA, CCG, (headquartered in Placentia, Orange County, California) we can be that trusted advisor! With years of expertise covering a broad range of business sectors- as well as the latest news, trends, laws, and regulations, we can make this process feel as simple as possible. With cost competitive pricing and a no obligation introductory call, you have nothing to worry about; contact us today!