How We Value a Private Business

There are a number of methods that can be used to valuate a business. Depending on your business, one may be more appropriate than another, or we may suggest a hybrid approach. Most valuation methods fall into one of the following three categories:

Asset Based Approach

This method is used to value businesses without transferable goodwill. Meaning there are insufficient earnings or cash flow and the business is not viable as a going concern, or the existing earnings or cash flows are not transferable to a new buyer. In other cases, asset values are the primary determinant of corporate worth, for example in a company whose value is derived largely from its portfolio of real estate holdings.

Income Approach

This method contemplates the continued operation of the business under new owners, meaning that the return on assets is sufficient to support transferable goodwill. The business value is determined by discounting future benefits to the new owners, to reflect the time value of money and the risk associated with earnings these future benefits. For mature businesses, the value is typically a function of its normalized earnings/cash flow times a multiple. Normalized earnings should reflect the average cash flow that a third party buyer would expect to earn from your business on an ongoing basis, common adjustments include non-market transactions such as shareholder salaries and personal expenses, and related party rental agreements. The multiple should reflect the macroeconomic, industry and company specific risk. The lower the perceived risk, the higher the multiple and the higher the business value. For startups or companies expecting significant and supportable future growth, a discounted earnings/cash flow method is usually most appropriate. Here, we would use future cash flow/earnings projections, discounted on an annual basis to reflect the macroeconomic, industry and company specific risk. The lower the perceived risk, the lower the discount rate and the higher the business value. In order to lower the perceived risk and increase value, projections should be supportable by historic growth rates, new customer contracts, specific cost saving measures or other rationale.

Market Approach

This method is a more general way of determining the value of a business by comparing industry specific earnings or revenue multiples to your business' earnings or revenue. We use public company multiples adjusted to reflect a size and liquidity discount as well as private company multiples obtained through private databases. Commonly used to test the reasonability of valuations determined using the asset or income approaches.

Summary

Determining the most probable selling price of a privately owned business comes down to the valuation professional making a professional judgment call based on a number of qualitative and quantitative factors and multiple valuation methods. This underscores the importance of hiring a highly qualified and experienced valuation professional when selling your business. The Chartered Business Valuator (CBV) designation is widely recognized as the premier credential for professional business valuators in Canada.

Greywood Partners is pleased to have Jennifer Cartwright, a Chartered Business Valuator since 2008, as part of our team. Should you have questions for any of our transaction professionals, or would like to know how companies in your industry are often valued, please don’t hesitate to contact us.