Business Valuation Part 4: Market Approach

Business Valuation Part 4: Market Approach

This post is part of a 4-part series covering business valuation and providing guideline information on the process of valuing a business. To start at the beginning and learn what business valuation is and why a business valuation is needed, read Part 1: Levels of Value. For an in-depth look at the first two valuation approaches, read Part 2: The Asset Approach and Part 3: The Income Approach. Part 4: The Market Approach In the market approach, the value of the organization can be compared to recent market activity whereby sales of similar interests in the same or similar industry. Valuation multiples, which are determined by dividing the sale price by a relevant financial metric (such as revenues), can be applied to the target company to determine an estimate of fair market value. When valuing minority interests, the value of an interest may be compared to recent market activity in equity transactions, reported through public exchanges (e.g. NASDAQ or New York Stock Exchange), of organizations in the same or similar industries, subject to similar risks. Pertinent price ratios are applied to the target interest to determine an estimate of fair market value. This method of the market approach is referred to as the publicly traded company method, guideline publicly traded company method or the GPC method. The notion behind the guideline publicly traded company method is that prices of publicly traded stocks in the same or a similar industry, provide objective evidence as to values at which investors are willing to buy and sell interests in companies in that industry. This method involves computing a value multiple using financial...
Business Valuation Part 3: The Income Approach

Business Valuation Part 3: The Income Approach

This post is part of a 4-part series covering business valuation and providing guideline information on the process of valuing a business. To start at the beginning and learn what business valuation is and why a business valuation is needed, read Part 1: Levels of Value. For an in-depth look at the first valuation approach, read Part 2: The Asset Approach. Part 3: The Income Approach The income approach considers the expected periodic cash return that could be derived from an ownership interest in the equity of a company.  The periodic cash flow stream can be developed in two ways: based on a discrete cash flow period then capitalizing the cash flow of the final period to value the cash flows beyond the projected period or directly capitalizing a level of normalized cash flow. To apply this model, we determine cash flows available to the equity investor, or as debt free cash flow.  Cash flows available to equity investors are used if we wish to directly value equity, whereas debt free cash flows are used if we intend on valuing total invested capital or total enterprise value, because this is the cash pool from which interest and dividends or distributions could be paid to all invested capital holders.  Formulas to calculate free cash flow to equity holders and free cash flow to all invested capital holders are shown below:   Free Cash Flow to Equity Holders Net Income +   Depreciation & Amortization –    Capital Expenditures –    Increase in Working Capital +   Increase in Interest-Bearing Debt Free Cash Flow to Equity Holders   Free Cash Flow to Invested Capital Holders...
Business Valuation Part 2: Asset Approach

Business Valuation Part 2: Asset Approach

This post is part of a 4-part series covering business valuation and providing guideline information on the process of valuing a business. To start at the beginning and learn what business valuation is and why a business valuation is needed, read Part 1: Levels of Value. Part 2: The Asset Approach The asset approach is also referred to as the adjusted net asset approach or the net asset value approach. All these names generally mean the same thing. This method is most appropriate when valuing a holding company (an entity holding various investment assets such as real estate and/or securities) or when valuing a marginally profitable company.  Companies such as those are valued based on their underlying asset values. The asset values are adjusted to their fair market values and the sum of the adjusted asset values is reduced by outstanding liabilities to determine the net asset value (or equity value).  This is basically a modified liquidation value approach (true liquidation value would include liquidation expenses) and generally yields a floor value for a controlling interest. The following simplified example below illustrates the steps involved in using the asset approach. In this example, the company has assets with a book value of $500,000 and liabilities with a book value of $450,000. Typically, current assets (such as cash, accounts receivable and prepaid expenses) are assumed to be equal to their fair market value. It is also generally assumed that the book value of inventory is equal to its fair market value, however, this may not always be the case if there is stale or obsolete inventory still sitting on the books....
Business Valuation Part 1: Levels of Value

Business Valuation Part 1: Levels of Value

This is Part 1 of a 4-part series that will serve as a valuation primer. The purpose of Part 1 is to give an overview of common terms and methods used to value an equity interest in a company. Part 1: Levels of Value The issue we are trying to resolve when valuing a business is the price that two independent parties would pay for or be willing to receive for the interest they hold. The value of a business interest depends on the future benefits that will accrue to it.  The financial benefits from ownership must come from one of the following sources: distribution of earnings, from the sale of the interest, or distribution from the liquidation of assets.  In determining the value of a business interest, one should focus on the benefits the shareholder(s)/member(s) may receive from long-term ownership in the securities. In appraisal terminology, these three sources of return correspond to the income, market, and adjusted net asset value approaches, respectively. When using each of the three approaches, the valuation analyst must also keep in mind the size of the interest being valued and the underlying financial information used to determine the value. This series of four valuation primers will cover the levels of valuation and the approaches to value. Minority Interests and Controlling Interests The value of a shareholder’s interest in the stock of a company is influenced by the shareholder’s access to and ability to distribute cash. In general, an ownership interest greater than 50% is considered a controlling interest and an ownership interest less than 50% is considered a minority interest.  The type...
What is a Business Valuation?

What is a Business Valuation?

A business valuation, or also sometimes referred to as a business appraisal, is a formal process to inform a business owner or a shareholder of the value of their interest in the company. A company can take many different forms and hold a variety of assets or perform a variety of services but a business valuation can use the information provided by a company to give an opinion of the value of that business. The most common request from a client is to determine what is called the fair market value of an equity interest. Fair market value is defined by the IRS as “… the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” The conclusion of value can be presented in a few different formats. A calculation of value is a valuation performed using previously agreed upon procedures between the valuation firm and the client. Typically a calculation of value relies on limited information from the company and the result is for informational purposes only. The results of a calculation of value are presented in a short letter with accompanying schedules. A conclusion of value can be presented in a summary report or a full formal report. A conclusion of value takes into account all available information on a company’s operations. The difference between a full formal report and a summary report is a summary report omits certain information that is not pertinent to the end user. For example, if the end...
Jason Bolt, CFA, ASA Joins Jones & Roth Business Valuation Team

Jason Bolt, CFA, ASA Joins Jones & Roth Business Valuation Team

Jones & Roth CPAs and Business Advisors are excited to announce that Jason Bolt, CFA, ASA has joined the Firm’s Business Valuation Team. Mr. Bolt holds expert knowledge in all areas of business valuation. His experience includes valuations of businesses in numerous industries (e.g. software, medical devices, convenience stores, forest products, manufacturing, professional services, retail/wholesale, agriculture, and restaurants). Mr. Bolt’s professional experience stems from his time providing valuation services since 2005 and his experience in corporate finance and his education at Cornell University where he studied corporate finance, investments, portfolio theory, and economics. His appraisal experience includes individual Client case management and all aspects of appraisal engagements including Client Company due diligence and valuation approaches and methodologies. His valuation experience includes appraisal engagements for a variety of purposes including M&A transactions, gift and estate tax, 409A valuation, and ESOP purposes. Mr. Bolt attends annual business valuation conferences which include annual Advanced Business Valuation Conferences offered by the American Society of Appraisers and Portland chapter meetings of the American Society of Appraisers. Mr. Bolt has qualified and testified as an expert witness in Oregon. Jason is active as a writer and presenter on business valuation education and thought leading...