Calculation of Value – Valuation Methodology
The Calculation of Value report is intended to provide an approximate indication of value based on the performance of a limited number of valuation procedures. This estimate of value is a guideline and should not be construed as a replacement for a complete, comprehensive valuation conducted by a qualified professional independent appraiser.
The Calculation of Value report is an opinion of fair market value – based on a going concern premise with management operating in a rational manner, with a goal of maximizing owner value of the underlying assets. Although there are multiple approaches to value, we calculate three methods: (1) Adjusted Asset Approach (asset approach), Discounted Future Earnings Approach (income approach), and the Direct Market Data Approach (Market Approach).
Method #1: Adjusted Asset Approach
Methods from the Asset Approach are often appropriate in the following situations:
• The company is considering liquidating or going out of business;
• The company has no earnings history;
• The company’s earnings cannot be reliably estimated;
• The company depends heavily on competitive contracts and there is not consistent, predictable customer base (e.g., construction companies);
• The company derives little or no value from labor or intangible assets (e.g., real estate or holding companies);
• A significant portion of the company’s assets are composed of liquid assets or other investments (e.g., marketable securities, real estate, mineral rights).
The asset approach is typically only used when the value of the business is heavily concentrated in its tangible assets or the business is not generating a high enough return on its assets to warrant “excess earnings” or “goodwill”.
Method #2: Discounted Future Earnings Approach
The discounting of future benefits to a present value is a theoretically correct method of value when investors are seeking a specific return on their investment. This method is dependent upon two inputs, the projection of the future benefits and the determination of a suitable discount rate. This method is often used when projected cash flows are expected to be uneven because of irregular growth or other factors.
The forecasting of earnings or cash flow and then discounting them to a present value is a valuation method appropriate when it appears that a Company’s current and historical operations do not indicate an expectation for stable earnings and a constant growth rate. This method provides for the recognition of a varying pattern of financial benefits and an annually changing rate of growth.
The application of this method requires the following critical decisions:
1. The selection of a type of financial return to be forecast (we’ve decided to use adjusted EBITDA);
2. A decision as to whether to use that return applicable to equity or invested capital (since we are using EBITDA, invested capital is applicable);
3. The number of years to forecast (we’ve forecasted 5 years);
4. The selection of a discount and capitalization rate to be applied to the return selected (modified build-up rate on EBITDA).
In essence, we are simply forecasting future cash flows, discounting the returns to their present values based on a discount rate specific to the risk of the investment. We then calculate a terminal value with the assumption the business will have value at the end of the forecast period. This “value” is also discounted and added to the sum of the present value of the future cash flows.
Method #3: Direct Market Data Approach
The Direct Market Data Approach [DMDA] develops a value based on the transaction values for which similar privately held businesses have been sold. The method assumes that if you take a large group of transactions of similarly structured businesses, the central tendency of the value ratios in such groups represents the value determined in a free and open market or Fair Market Value. The size of the group has been demonstrated to require more than five transactions.
We use a transaction database, which, when first published in 2009, contained over 7,000 transactions. The information was gathered from SBA lenders, and involves transactions specifically financed by SBA lenders – and has been updated daily since inception.
Price for Calculation of Value
While typical business appraisals often start at $5,000, the cost of our Calculation of Value is a fraction of this cost. Click HERE to see a sample report. Contact Tom MacPherson, at the Charlotte office, for the cost of a Calculation of Value and what we need to prepare one.
The Summit Acquisitions Group — Business Brokers and M&A Advisors — specializes in the sale, appraisal, and financing of privately owned companies ranging in valuation from $750,000 to $25,000,000. Contact their offices in Atlanta, GA or Charlotte, NC for a free consultation.