The reality is that determining the value of a business is anything but a simple question. There are many ways to estimate the value of a business . . . and “off the top of my head” is one that I generally will not use!
There are many commonly used rules of thumb, which can include: multiples of profit, multiples of annual or monthly sales, and multiples of square feet. If a very general estimate is all that is sought, one of these methods can provide a ballpark figure. It is important to remember that, as a ballpark estimate, it should be confirmed with proper valuation methods, before it is a determining factor in decision-making.
If a realistic valuation is needed, there are at least three key elements that need to be considered. These are:
- Asset valuation;
- Historical earnings valuation;
- Future sustainable earnings valuation.
This article will deal with asset valuations. Assets include both hard assets and intangible assets, or goodwill.
When looking at the value of equipment, it is important to note that there are many different ways of determining value, because the value is affected by whether it is new or used, installed or crated, and its overall condition. For instance, a brand new printing press may cost ten times more than a used press, but to move and install a used press may cost many thousands of dollars.
Estimating the value of equipment can be very specialized, depending on the type of business. Even as a business intermediary who specializes in determining the value of a business, I will often call in third-party valuation assistance from a qualified equipment appraiser when performing this aspect of the asset valuation method.
An equipment appraiser will assess the type and condition of the equipment, and its availability in a used equipment marketplace, and provide a fairly accurate look at its value. We always ask the appraiser to give us three values: 1. installed and operating in-place value; 2. used sale and orderly liquidation value; and 3. auction value.
The business owner’s bank will be interested in the auction value, while insurance companies will want to know the installed value. Business owners need to know the orderly liquidation value in case they need to replace the equipment at some point in the future.
Goodwill is the intangible asset we look at very carefully. In the business world, goodwill is the amount that a purchaser is willing to pay over and above the actual dollar value of a company’s tangible assets, such as its building, equipment, fixtures, accounts receivables, inventories, etc.
Goodwill can be looked at as the ability of a company to generate profits in excess of those profits required to provide a reasonable return on capital invested. The amount of goodwill that a particular company has can be affected by many things such as the company’s established clientele, its length of time in business, any trademarks or patents, contracts, or even proprietary processes. We have just completed the evaluation of a mid-sized printer who anticipates his revenue will increase 50 to 60 % as a result of the addition of new equipment. He already has the customer, so placing a value required carefully detailed projections for the next three years, including discussions with the customer to confirm his contract with our client.
A prudent purchaser will look very closely at the last three to five years of financial results and will carefully scrutinize and assess the future prospects of the business before determining the value of goodwill he is prepared to pay.
Goodwill is great to sell – from the seller’s tax point of view; and terrible to buy – from a buyer’s tax point of view. Goodwill will sometimes be negotiated as something else, either a higher value of the equipment, a consulting contract, or a royalty payment. There are many ways to allocate goodwill, both on and off the balance sheet.
Determining the value of a company’s assets is only one of the key elements in defining what any company is worth. Remember, “the true value of any business, lies in the future profitability of that business, as seen by the Buyer.”