Value Blog

Valuable Answers to Your Business Valuation Questions

16 Nov

Why do I need a valuation if I am buying a business?

Posted in General valuation topics, Uncategorized on 16.11.09

The straight answer is you may not.  Unless the transaction is between family members or will be financed with an SBA loan, a valuation is usually not required.

The advantage to a business valuation is it provides the user with the value of a business or interest in that business.  The advantage to a business valuation is also the major limitation.  The business appraiser will usually provide a single value, based either on fair market value or investment value.  (See blog post here)

Value is a range, though, and there are many different types of value within that range.  As a buyer, you are only concerned with the lowest value within that range that you can pay.  If you can negotiate a lower price than fair market value, you will.

Valuations can be expensive.  If one is not necessary for you to negotiate a deal, you should not pay for one.

The seller has established a starting price for your negotiation.  What you need to determine is whether the cash flow from the business can support that price.

Each buyer has different criteria for whether a deal will work for him or her and there is no right answer.  The things that buyers should consider include:

  • What is your risk tolerance?
  • What is your required rate of return?
  • How long are you willing to wait to get your investment back?
  • Will cash flow from the business be sufficient to pay off any debt used to buy the business?
  • Will cash flow from the business be sufficient to pay your salary if you are working in the business?

These questions will provide you will the information to determine if the asking price meets your criteria as a buyer.  A business may be worth $100,000, but a particular buyer may not be able to afford the asking price.

Price is the negotiated amount for a particular transaction.  While you need information to make an informed decision, a valuation will not necessarily give you that information.  Your financial professional should be able to assist you in determining whether the asking price of a business meets your criteria.

© 2009 Florida Business Valuation Group

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20 Jul

What does the market approach capture?

Posted in General valuation topics on 20.07.09

The conceptual background behind the market approach is to use the behavior of buyers and sellers to arrive at a multiple which reflects the market.  Market methods can be divided into two basic groups: guideline public companies and private company transactions.

There are some major distinctions between the underlying data used for each method.  The public guideline company method uses information from publicly traded companies that are most similar to the company being valued.  The appraiser’s analysis of comparability may include factors such as type of business, size, geographic operations, growth prospects, past historical operating performance and any other factors which may be appropriate.  The appraiser identifies the most comparable companies and then derives valuation multiples based on the trading prices of the guideline companies’ stock as of the valuation date.  This data is based on marketable, minority interests in the guideline companies.

Private company transaction methodology is generally based on the theory that a sufficient number of private transactions will emulate the market for that type of company.  There are a number of databases which track private transactions of companies.  The information is collected from business brokers and intermediaries involved in the transactions, who report the information to the database services.  Each database contains different amounts of information regarding the companies.  The information about these companies represents a non-marketable, control interest in the transaction companies.

So what is the difference?  The public company transactions are evidence of the market value based on a large number of transactions which have been completed between buyers and sellers.  That is the reason that a large number of public companies is not required in order to use the methodology to arrive at valuation multiples.  Each company alone is evidence of the market.

Private company transactions may or may not take place at market value. Buyers and sellers have their own motivations for entering into transactions.   There is only one transaction for each company, unlike with public companies where you could have anywhere from under one million to over 250 million trades in a single day.  The concept behind private company transaction methodology is that with a sufficient number of transactions, the average or mid-point will represent what the market looks like.  That is why more transactions are necessary under the private company transaction methodology.  A few transactions may not be sufficient to represent the market.

What is important to understand is that each valuation is different. Applying any methodology is based on the facts and circumstances particular to the company being valued and the valuation date.

©2009 Florida Business Valuation Group

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11 Jun

Does a single transaction represent market value?

Posted in General valuation topics on 11.06.09

One of the approaches to valuing a business is the market approach.  This approach looks to either private transactions or publicly traded stock to develop an indicator of value, usually in the form of a multiple.   Is a single transaction representative of the value in the market?

With public companies, the marketplace allows for buyers and sellers to negotiate each transaction by using bidding system.  A buyer will indicate what he wants to pay for a stock and a seller will indicate what he wants to sell the stock for.  When buyers and sellers are matched, there is a sale.  The public stock exchanges provide an efficient system for trades.

When a public guideline company method is used to value a business, comparable companies are identified and the information from the market is used to develop a market value.  Because the data captures the prices paid in the market, it is considered to be a good proxy of fair market value.  Since there are many transactions for each company, it is not necessary that an appraiser use a large number of comparable publicly traded companies in applying this methodology.  (The IRS heavily favors using publicly traded companies as a basis for value in developing opinions of value.)

When comparable publicly traded companies are not available, we look to private markets.  Private markets are no where near as efficient as publicly traded markets.  Often, limited information is available about the sale and the company operations.  Private companies are not require to report information and most information available is from database services that collect the information from brokers and intermediaries.

Since private markets are not efficient, the sales prices usually reflect an investment value rather than fair market value.

With all these challenges, how do we use these private transactions to develop indicators of fair market value?  Using private transactions is based on the concept that when transactions for similar companies are looked at together, these values represent the market as a whole.  The values for companies sold at distressed prices offset the values for companies sold at premiums, resulting in a market value.

Since the private transaction methodology relies upon a group of transactions to extrapolate multiples representative of the entire market, it is necessary to have a sufficient number of transactions to achieve this.  The problem is there is no absolute number.  We know that you need more than five transactions to get a statistically valid multiple.  Most agree that you need more than ten transactions.  The obvious answer is the more the better. With more transactions, an appraiser is better able to analyze the data into groups and arrive at a multiple based on factors that are similar to the company being valued.

While a single transaction price may be representative of fair market value, it is not sufficient to prove fair market value.  Remember price does not necessary equal value.  Price is the negotiated amount at which a transaction takes place and can be influenced by non-market factors.

For more information on the market approach, click here.

©2009 Florida Business Valuation Group

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