In order to properly prepare the sale of your business or the start of an acquisition project, you must verify its valuation. There are many business valuation methods: estate method, cash flow method, comparative method, performance-based method, scale method, etc.
In this document, we show you the main business valuation methods, the selection of valuation methods and the adjustment of the calculated amount according to important standards.
DIFFERENT METHODS OF BUSINESS VALUATION
To evaluate the selling price of your business, there are many possible valuation methods. Below, we will present the following four main methods:
Depending on your situation, you should choose one or two appropriate valuation methods and then adjust the amount obtained according to the criteria deemed important.
The evaluation phase is very important. However, it only provides an idea of the value of your business, and then the final selling price will be negotiated with the buyer.
VALUE YOUR BUSINESS USING TRADITIONAL METHODS
The patrimonial valuation method includes the valuation of each asset and liability (debts and risk reserves) on the company’s balance sheet to obtain the adjusted and revalued “net assets” corresponding to the value of the company.
The valuation of each item is very important, as the book value does not usually reflect the true value of the asset or liability, so it must be revalued. In order to apply the appropriate method, the correct valuation method must be used.
VALUE YOUR BUSINESS BASED ON PERFORMANCE
Valuing sales prices based on business performance involves applying percentages or numbers to performance indicators. For example, we can use financial indicators such as sales profitability, value added, total operating surplus, profit, etc.
The company’s selling price can be evaluated based on key business indicators for certain activities.
For example, it can be the number of subscribers of the company publishing the store, the number of page views or audience of the company publishing the website, the production of the company manufacturing products or materials…
USE THE FREE CASH FLOW METHOD TO VALUE YOUR BUSINESS
This method, also known as the “DCF method”, estimates the market value of the business by adding the after-tax free cash flow to the investor’s required rate of return and then subtracting the value of the net debt.
Free cash flow is calculated as follows:
Free cash flow = total operating surplus – theoretical corporate tax on operating income – change in working capital – disposal of net investment assets.
This valuation method is based on the company’s performance over the next few years, and the cash flow is calculated on the basis of forecast data, and is therefore hypothetical. As a precautionary measure, several situations must be anticipated. The choice of the duration and the discount rate is a difficult and decisive task for the valuation of a company.
The advantages of the free cash flow method lie in the future of the company rather than in the past, and in future profitability rather than in the assets. However, the application of this method is very sensitive to the assumptions made. In order to make calculations, predictions must be made over a relatively long period of time.
If you use this complicated technique, it is best to have a CPA or business transfer expert assist you.
USE COMPARATIVE METHODS TO VALUE YOUR BUSINESS
The comparison method consists of valuing your company on the basis of a sample of comparable companies that must have the same sectorial, geographical and operational characteristics.
You can also rely on recent disposals of comparable companies.
Therefore, to determine the valuation, you need to find several companies similar to yours and their sale prices or values (when they have not yet been sold). Then, your price must be adjusted according to several important criteria related to your event (see here).
The advantage of this method is that it provides a transfer price consistent with the current market. However, in the absence of comparable companies nearby, the application of this method is impossible.
VALUE YOUR BUSINESS ON THE SCALE
Small businesses typically use the percentage of revenue criteria used by appraisers and courts for valuation. This method provides a transfer price valuation that does not take inventory into account.
Caution should be exercised with this approach as it does not reflect the profitability of the business and does not take into account the location, reputation, production tools and/or condition of the business.
The scale method provides the concept of the average selling price of companies in the same sector.
ADJUSTING THE VALUATION ACCORDING TO MATERIALITY CRITERIA
Next, the first valuation according to the method of your choice must be adjusted according to several important criteria. These important standards are a combination of general standards and standards that depend on the business you are in.
Here are some examples of general standards:
– Ongoing litigation can lower valuations,
– Loyal and diverse customers can increase valuations,
– The importance of the manager’s relationship with the business reduces valuations…
Here are some examples of standards related to the activities performed:
– For production companies: the condition of production tools and possible components to be replaced,
– For local businesses: the conditions and location of the premises.
HOW TO CHOOSE AMONG THESE VALUATION METHODS?
Each method described above has its own advantages and disadvantages, so you need to determine which method suits you best. To do so, we recommend that you carry out a valuation with your accountant or your business transfer expert.
In practice, for VSE/SME transfers, we generally use the comparison method and the scale valuation method to evaluate the transfer price. Then there is the method recommended by the event service, so you need to understand it.
In all cases, we recommend that you keep the comparison method between the chosen valuation methods to be consistent with the current market. Potential buyers looking for targets will compare several similar companies for sale (similar to the real estate market) before making a choice. Selling prices above the average market price will reduce your chances of finding interested buyers.
The result of the valuation of your business is still theoretical and the actual selling price will be determined by the opportunities that arise and the negotiations between you and the buyers.
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