“One of the most discussed aspects of selling a business is undoubtedly the business valuation and the preparations needed to make the transaction actually happen, “says Achim Neumann, President, A Neumann & associates, LLC, a New Jersey based M&A advisor and business brokerage firm, “however, the metrics for arriving at a Fair Market Business Value are fairly straightforward.”
Essentially, there are three generally accepted approaches commonly used to creating a worthwhile business valuation, which are:
- Income approach,
- Market approach, and
- Asset-based approach.
“Within each category, a variety of methodologies exist,“ says Scott McMahon, Partner, MR Valuation Consulting, LLC, New Jersey, “ in order to assist in the estimation of fair market business value.” The following sections contain a quick overview of the theoretical basis of each approach.
The income approach business valuation is based on the premise that the value of a business is the present value of the future earning capacity that is available for distribution. The most often used income approach to the valuation of businesses is a discounted cash flow analysis which involves forecasting the respective cash flow stream over an appropriate period and then discounting it back to a present value at the prevailing discount rate for the market segment. Another common approach is the capitalization method – dividing the economic income by an estimated discount rate, less growth. The discount rate should always consider the time value of money, inflation, and the risk inherent in ownership of the business or business interest being valued.
The objective of the market approach business valuation method is to identify comparable transactions and price multiples where the target company’s business and financial risks are similar to those of comparable companies. Key criteria for such comparisons are typically purchase prices, EBITDA, and Revenue multiples. This method uses sales of similar companies to derive a value.
A third approach to the business valuation is the asset-based business valuation approach based upon the concept of replacement as an indicator of value. The asset-based approach establishes value based on the cost of reproducing or replacing the property. The asset-based approach is generally used to estimate the value of companies that do not generate income directly – with an asset base that is mainly comprised of tangible assets. For example, the asset-based approach is used for real estate holding companies and investment holding companies.
Once all three business valuation approaches have been weighed against each other, the derived value obviously needs to make sense from an investor’s point of view. For that matter, business valuation firms in New York to Los Angeles should provide a Price Justification Chart, outlining to a potential investor the Return-On-Investment for a particular company.
A good business valuation firm will present the most educated number based on research, analysing the numbers correctly after performing the three aforementioned business valuation methods, as well as lending localized/industry related knowledge.
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About A Neumann & Associates, LLC
is a professional mergers & acquisitions and business broker firm having assisted business owners and buyers in the business valuation and business transfer process through its affiliations for the past 30 years. With an A+ Better Business Bureau rating and over 5,000 valuations performed through its affiliation, the company has senior trusted professionals with a deep knowledge base in multiple field offices from Connecticut to North Carolina.
About MR Valuation Consulting, LLC
MRV Consulting is an independent valuation advisory consulting firm that provides appraisals, business valuation, cost segregation analyses, valuation consulting, litigation support, and expert witness testimony to clients worldwide. Our recommendations and value conclusions provide the support required for the completion of transactions to satisfy mergers and acquisitions, divorce, disputes, financial, tax, and management reporting requirements.