The 3 Most Effective Methods to Determine Your Company's Value

Copyright 2006 John J Reddish How much is your company worth? How much of that worth is attributable to your performance? Is a valuation for estate, or divorce, purposes a true reflection of the business worth? These are tough questions and they make calculating the selling price of a closely held company difficult. Although there are three generally used methods of valuation -- industry norms (usually based upon some multiple of earnings computation), comparable sales of public companies, and formula approaches -- no one method does a consistently good job of expressing the value of the closely held business for purposes of (the various types of) sale. Attempting to consider a purchasing decision, or structure a selling price, on factual data (when available and confirmed) is, however, a worthwhile of estimating approximate value. Collectively used, these 3 valuation methods can help establish an objective range of value, which provides the basis for successful negotiations and sale. Even with objective values, the watchword in buying a closely held business remains, Buyer Beware. The closely held company is one of those strange animals that can alternately command pennies or fortunes. It can be, and often is, worth whatever you can get for it. What you value and how you value it, are critical to the process. Some items that had been deeply discounted or handled as contingent liabilities in prior years are now viewed more as key elements in a sale - the value of key employees and contractors governed by sound (and enforceable) golden handcuffs and the value of software licenses, for example. Valuations for estate purposes, or equitable distribution (divorce), however, are seldom reflective of a true selling price. That's not their purpose. Use such values warily when considering a sale. Also, be aware that a sale in too close proximity to a key owner's death or divorce might result in the sale being challenged if the value is significantly different. In preparing to conduct a valuation, a true picture of the company's performance must be prepared. Unfortunately, the tax code is structured in such a way that there is little incentive for the private company to show comparable profits to its publicly traded counterparts. Thus, declared earnings often do not mean much. Before applying any model, a valuation expert will need to "recast" the financial statement, taking tax shelter considerations out of the picture and presenting new numbers based on what the company's performance would look like if run by hired managers. In the industry norm method, the company will be compared with other assumedly similar companies in their industry that have sold at various multiples of (recast) earnings. That's OK if the company is truly a typical company. If the company has either proprietary products or services or market position that make them unique, the multiples approach negates that uniqueness. The comparable sales method presents similar problems. Are the sales being compared truly comparable? Few public companies have the same infrastructure as their privately held counterparts. Key to a comparable sales method working is the ability to compare "apples and apples". There are dozens of formulas used in valuation analysis. Formulas can establish ranges of values. Using both the right formulas and knowing how to interpret them for a given business can give a close indication of true value, but ratios derived from "norms" (averages) also produce a leveling effect. Confused? What is your company worth? It's worth whatever you, the seller, will accept. It's worth whatever the purchaser is willing to pay you. Reviewing objectively prepared vales and going over them help bring a sense of reality to a transaction that can be very emotional. Using traditional valuation methods help to establish guidelines, which usually put buyer and seller in the same ballpark. Selling a family or entrepreneurial, business isn't like selling a product or even a service; it's like selling a piece of yourself. If you engage the right advisors, give yourself time (usually 1-3, or more years) to find the best buyers and are realistic about the possible outcomes, you can increase the likelihood of achieving a successful sale. And what's that really worth?