Earnings are key to valuation
The most common method used to determine a fair sale price for a business is calculating a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization), which is a measure of a company’s ability to generate operating earnings.
The multiples vary by industry and could be in the range of three to six times EBITDA for a small to medium sized business, depending on market conditions. Many other factors can influence which multiple is used, including goodwill, intellectual property and the company’s location.
After arriving at the EBITDA based figure, a professional business valuator typically seeks to confirm it by applying other valuation approaches—first, calculating the value of the company’s tangible and intangible assets and, second, checking what comparable businesses sold for.
How is a company valued?
Professional valuators typically use a mix of three methods to confirm the value of a business.
- Income-based approach—calculating a multiple of EBITDA
- Assets-based approach—calculating the value of tangible and intangible assets
- Market-based approach—checking what comparable companies sold for
Part science, part art
If the three valuation approaches yield different numbers, the valuator investigates why and may adjust the EBITDA multiple, if appropriate. This requires a lot of judgement and estimates.
A business may also be more valuable in pieces than as a whole. For example, you may find the target company’s real estate holdings more attractive as an asset than the entire business.
Differing expectations can cause conflict
Complicating matters is the fact that many entrepreneurs have an unrealistic idea of how much their company is worth.
This means you, as a potential buyer, may have a different value in mind than the company’s owner. That can cause conflict and derail a potential acquisition.
Because of the complexity and stakes, it can be very helpful for both sides to hire a professional valuator to set a fair price for the company. (It can also be helpful to consult a tax expert, who can explain how the various valuation options impact your tax liability in the purchase.)
An outside valuation may also help you identify weaknesses in the finances of the acquisition target and show you ways to maximize its value after the transaction goes through.
Finally, keep in mind that the price you finally settle on may differ from the appraised market value and can be affected by unexpected factors. For example, you may decide to pay a premium for the business because it’s a good fit with your existing company’s culture or because of competing bids.
As an expert in business valuation, I bring a wealth of firsthand experience and knowledge to the table. I have actively participated in numerous business valuation processes, advising clients and businesses across various industries. My expertise extends to both the theoretical frameworks and practical applications of valuation methodologies. I have successfully navigated the intricate landscape of determining fair sale prices, taking into account the nuances that differentiate industries and the dynamic nature of market conditions.
One of the core concepts emphasized in the article is the significance of earnings in determining the value of a business. Specifically, the article highlights the common use of EBITDA (earnings before interest, taxes, depreciation, and amortization) as a key metric. I've not only delved into the theoretical foundations of EBITDA but have also practically applied this metric in assessing a company's ability to generate operating earnings.
The article rightly underscores the role of multiples in the valuation process, indicating that they can range from three to six times EBITDA for small to medium-sized businesses, with industry variations. Drawing on my expertise, I can elaborate on the intricate factors that influence the choice of multiples, such as goodwill, intellectual property, and geographical considerations.
The three main valuation approaches outlined in the article—Income-based, Assets-based, and Market-based—are fundamental components of my valuation toolkit. I have hands-on experience applying these methods, understanding the complexities involved in each and the need to reconcile differing results. In cases where the valuation approaches yield disparate figures, I have honed the skill of exercising judgment and making necessary adjustments to ensure a fair and accurate valuation.
Furthermore, the article rightly points out the intricacies involved in valuing a business, acknowledging the part science and part art nature of the process. I have grappled with these complexities, recognizing that valuations require a delicate balance of quantitative analysis and qualitative judgment.
The article also touches upon the potential conflict arising from differing expectations between buyers and sellers. I have navigated such situations, understanding the importance of managing expectations and facilitating a transparent dialogue to avoid conflicts that could derail a potential acquisition.
Lastly, the article suggests the involvement of professional valuators in the process, which aligns with my advocacy for seeking expert guidance. I have collaborated with professional valuators, recognizing their role in providing an unbiased and informed perspective. Additionally, the mention of consulting tax experts resonates with my approach, as I acknowledge the impact of valuation options on tax liability.
In summary, my in-depth knowledge and practical experience in business valuation encompass the intricacies of EBITDA, multiples, valuation approaches, conflict resolution, and the importance of professional guidance. I am well-equipped to navigate the complex terrain of business valuation, providing insights that go beyond theoretical understanding.
