Robert P. Mino, PA, leverages several commonly used valuation methods for your business.
This methods assumes your business is worth at least the owner’s equity on the balance sheet. This value is not the most accurate in that it relies heavily on historic information and depreciation, without appropriately valuing certain future costs. This method is often used as the basis for a bare-minimum asking price for a business or at least the starting point for some serious negotiation. Certain businesses will be less than the balance sheet number, some – like early stage life sciences companies – can be worth significantly more.
Assets and Earnings Valuation
The IRS most commonly uses this method when they value a business for estate or gift tax issues. Essentially, the financial statements are recast to show the business without owner salary, perks, and benefits and is, ideally, averaged over a 3–5 year timeframe. The starting point for this valuation method is usually the net value of the assets as they appear on the recalculated financial statement.
Capitalization of Income Valuation
This is typically the best method to use for service businesses or for businesses in which a single owner has led the business for many years. This method factors in several risk factors and other intangibles to value the business. The risk factors can be listed and then assigned a rating based upon a scale of one to five, with five being the highest rating. The average score can then be multiplied by the buyer’s discretionary cash to establish market value. These factors can range from:
- Barriers to entry
- Customer base
- Degree of risk associated with this type of business
- Growth history
- Owner’s reason for leaving the business
- Years of continuous operation
If you add up the total of the ratings assigned to each topic and then divide by the number of topics, this creates the capitalization rate. This number is then multiplied by the buyer’s discretionary cash and the result can be considered the market value.
Owner Benefit or Historical Earnings Valuation
The owner benefit method assumes a 10% return on investment is the necessary rate of return for assumption of average business risk. These calculations begin with the company’s net earnings, including a reasonable owner’s salary minus capital improvements and working capital increases, with the depreciation figured back into the equation. This number, which is generally referred to as free cash flow, is multiplied by the number of years it will take to pay off the loan required to purchase the business. Subtract the down payment, and what remains is what will be left to make interest and principal payments on the loan, plus a moderate return on investment for the new owner.
The method typically utilizes a standard multiplier of 2.2727, which is based upon a 10 percent return on investment for the buyer, a living wage equal to 30 percent of the owner’s benefit, and a debt service of 25 percent. A skilled valuation expert, like Robert P. Mino, can assist in evaluating the variables.
Multiplier of Market Valuation
This method is the “rule of thumb” for the average person, and is often cited on television entrepreneur shows, but is the worst method to use by the unskilled person. The problem this method has is that it does not reflect differences between two businesses in the same industry. It is based average recent similar business sales prices and is generally figured as a multiple of gross sales. Also, the average person often is unable to develop the appropriate multiplier variable or the value upon which to multiply. Robert P. Mino is experienced in these areas is available to help.