The valuation of businesses has grown to be both a science and an art and you have to respect and pay attention to both pieces to properly value a business.
Louisville, KY (PRWEB) March 16, 2012
The availability of inexpensive and quick-turnaround options to get a private business valued has Brian Mazar, CEO of American Fortune Mergers & Acquisitions, steaming. “Anyone can study and learn the mechanics of placing a value on a business, but those metrics should be the foundation for the rest of the valuation, not the final result,” Mazar emphasizes. And with that statement, Mr. Mazar released American Fortune’s tips on what a quality business valuation should include and what elements, beyond the foundational metrics, should be considered in a proper business valuation.
“The valuation of businesses has grown to be both a science and an art and you have to respect and pay attention to both pieces to properly value a business,” advises Mazar. To arrive at a defensible valuation, a valuation professional needs to follow the standards and norms that have been developed by experts in the business valuation field. But, many well-intentioned valuation professionals fail to produce accurate and defensible valuations because they do not possess the second part of the valuation, which is knowledge of the "art". The art portion of a valuation comes from the forces of the market and the dynamics associated with expected rates of return for given risks.
So what is the “art”? According to Mazar, it’s “the strength of the industry, the culture of the business,the competitiveness, the dependency of the business on the owner, the future viability of the company and the present economic and market conditions.
There are three common approaches used by certified business appraisers to perform a business valuation, although there may be additional approaches used as well. The American Society of Appraisers has developed appraisal standards for the Asset Based Approach, the Market Approach and the Income Approach.
The Asset Based Approach, sometimes referred to as the Cost Approach, is asset-oriented and is a viable method to conduct the “mechanics” portion of the valuation. For this approach, each component of the business is valued separately and then summed to derive the total value of the business. The “art” portion of this valuation is the adjustment of these values to reflect their fair market value, which results in an adjusted book value. Once market and economic conditions have been factored into the value, the company’s liabilities will be subtracted out and this will determine the businesses value.
The Market Approach is based on an analysis of the purchase price of similar businesses in the market. “This can be a great way to value a company,” shares Mazar, “but the evaluator must have ample information about what the market and economic environment was like at the time these companies sold.” For the Market Approach, financial ratios are used to compare the subject company to other companies and a set of appropriate multiples are developed to be used in the valuation. An earning period is then selected and earnings and cash flow are analyzed over these periods using the multiples. A value is selected based on how the company compares with the others.
The Income Approach focuses on the earnings of the business. The value is based on an estimate of the income the purchaser could reasonably expect from the business. The computations generally determine that the value of the business is equal to the expected future income of the business divided by the rate of return.
For the final valuation total, the Business Valuation expert typically determines a relative weight to be assigned to each of the various methods used. Occasionally, they may decide that the value should be derived from a single method. It is possible that one or more approaches may not be relevant to the particular situation. Typically, the rationale will be included for the selection of weighting of the method or methods used in reaching the final value.
No doubt, parts of a valuation are very subjective. How expert #1 feels about a market environment might be vastly different from how expert #2 feels. A business owner needs to be aware of this but not avoid it. If a valuation is void of the “art” or subjective part, it is an incomplete valuation. Since valuations are based on 50% mechanics and 50% art (market forces), it is very critical the evaluator is very versed in both aspects.
American Fortune Mergers & Acquisitions, LLC is a nation-wide firm that provides services in the areas of growth-to-exit planning, mergers and acquisitions and business valuations for businesses with revenues between $3 million and $100 million. American Fortune was founded by industry veteran Brian S. Mazar who developed a unique buying process that is sell-side driven. Due to this process, American Fortune successfully sells their businesses at an average of 98% their listed price.