Valuation of Business

1.

Valuation of
Business
NVC-TW10
Alisher Ismailov

2.

Agenda
• Buying and existing business
• Due diligence before purchasing
• Business Valuation & Its methods
• Determining the Business Value of your
business

3.

Buying an
existing
business
• It is less risky than starting from scratch because facilities,
employees, and customers will likely be in place.
• To acquire a business with ongoing operations and
established relationships with loyal customers and
reliable suppliers
• The business has established trade credit, which is crucial
because relationships with suppliers and others take a
long time to develop.
• It is easier to own a business if the entrepreneur has
limited business experience, especially if the owner stays
on for a time to help with the transition.
• To begin a business more quickly than starting from
scratch
• To obtain an established business at a price below what a
new business or franchise would cost

4.

What to
Look For
in a
Business
• A business that had a broad scope that would
insulate it from market downturns.
• A business with existing customers and vendors
• A low-tech business with high growth
• A market that was not so large as to encourage
significant players but not so small that the
company couldn’t grow.
• Available float from suppliers; in other words,
leeway in paying vendors.
• Manageable seasonality
• Cost cutting potential

5.

Investigating
and
Evaluating
Available
Businesses
Due Diligence
• The exercise of prudence, such as
would be expected of a reasonable
person, in the careful evaluation of a
business opportunity
Relying on Professionals
• Accountants
• Attorneys
• Other experienced business owners

6.

Find Out
Why the
Business Is
For Sale
• Owner’s stated reasons for selling the business
• Poor health or illness in the family
• Wants to retire while he can still enjoy life
• Desires to relocate to a different section of
the country
• Has accepted a position working for another
company
• Wants to start a new business in a different
industry
• Has to sell the business to generate funds to
settle a divorce, lawsuit, etc.
• Beware of sellers who may have priced the business
at more than its worth or who have “cooked the
books” to make the business appear to be more
attractive than it really is.

7.

The
potential
reasons
could be
Larger companies are squeezing the firm out of the market
Key employees have been leaving
The industry is very mature and there aren’t any new ways or
places to grow
Competitors’ products (or services) are superior
The business has developed a negative reputation in the
community
The firm is facing a pending lawsuit
The business is just not profitable
The physical facilities are old or obsolete and in need of major
renovation/repairs

8.

Examining
the
Financial
Data
Review financial statements and tax returns for the
past five years.
Recognize that financial data can be misleading.
Assets overvalued
Expenses under-stated
Income over-stated
Unrecorded debts
Adjust asset valuations to reflect the true state of the
business.

9.

Business
Valuation
• Business valuation is the process of determining
the economic value of a company or
organisation. The valuation provides an
estimate of what the business is worth and is
usually done by professional appraisers,
accountants, or investment bankers.

10.

Why to do
Business
valuation
• Business valuation is important for various reasons,
including:
1. Mergers and Acquisitions: A company may want to
buy another business, and business valuation helps
determine the target company’s value.
2. Sale of the Business: A business owner may want
to sell their business, and business valuation can
help determine a fair asking price.
3. Financing: Business valuation is essential when
raising capital from investors or getting a loan from
a bank.
4. Tax Purposes: The value of a business is essential
for estate and gift taxes, and business valuation
provides a fair value for tax purposes.
5. Litigation: Business valuation is essential in legal
proceedings, such as shareholder disputes, divorce
proceedings, and bankruptcy.

11.

Business
valuation
Methods
• Market Approach: This approach determines
the value of a business by comparing it to
similar businesses that have sold recently.
• Income Approach: This approach determines
the value of a business based on its current and
projected income stream.
• Asset Approach: This approach determines the
value of a business based on its assets and
liabilities.

12.

The
Market
Approach
The market approach is a business valuation method that determines the value of a
business by comparing it to similar businesses that have sold recently. The market
approach is based on the assumption that similar businesses in the same industry will
have similar valuations.
The steps in the market approach for business valuation include:
• Identify Comparable Transactions: The first step is to identify comparable
transactions or businesses that have sold recently in the same industry. These
transactions should be similar in size, location, industry, and other relevant
factors.
• Adjust for Differences: Once the comparable transactions have been identified,
adjustments are made for any differences between the subject business and the
comparable transactions. For example, if the comparable transaction had a higher
growth rate or a better location, an adjustment would be made to account for
these differences.
• Determine Valuation Multiples: After making the necessary adjustments,
valuation multiples are determined based on comparable transactions. These
multiples are ratios that compare the price of the business to a financial metric
such as revenue, EBITDA, or net income.
• Apply Multiples to Subject Business: The next step is to apply the valuation
multiples to the subject business. For example, if the average valuation multiple
for the comparable transactions was three times the revenue, and the subject
business had revenue of $1 million, the estimated value would be $3 million.
• Consider Additional Factors: Finally, additional factors such as the current market
conditions, growth potential, and industry trends should be considered to ensure
that the valuation is reasonable and accurate.

13.

Market
Approach
Example
Let’s say you want to value a small retail store that sells home décor
items. You identify three comparable transactions, all in the same
industry and with similar sizes and locations. The first transaction sold
for $500,000, had revenue of $1 million, and a growth rate of 5%. The
second transaction sold for $550,000, had revenue of $1.2 million, and
a growth rate of 7%. The third transaction sold for $480,000, had
revenue of $900,000, and a growth rate of 3%.
1. First, we need to calculate the revenue growth rates for the three
transactions.
• Transaction 1: (Revenue Year 2 - Revenue Year 1) / Revenue Year 1 =
($1 million x 1.05 - $1 million) / $1 million = 0.05 or 5%
• Transaction 2: (Revenue Year 2 - Revenue Year 1) / Revenue Year 1 =
($1.2 million x 1.07 - $1.2 million) / $1.2 million = 0.056 or 5.6%
• Transaction 3: (Revenue Year 2 - Revenue Year 1) / Revenue Year 1 =
($900,000 x 1.03 - $900,000) / $900,000 = 0.033 or 3.3%

14.

Market
Approach
Example
• 2. We calculate the valuation multiples by dividing the transaction
value by the business revenue.
• Transaction 1: Valuation Multiple = $500,000 / $1 million = 0.5
times revenue
• Transaction 2: Valuation Multiple = $550,000 / $1.2 million =
0.46 times revenue
• Transaction 3: Valuation Multiple = $480,000 / $900,000 = 0.53
times revenue
• To determine the most appropriate valuation multiple for the
subject business, we can take an average of the three calculated
valuation multiples:
• Average Valuation Multiple = (0.5 + 0.46 + 0.53) / 3 = 0.4967 or
approximately 0.5 times revenue
• Therefore, the estimated valuation multiple for the small retail store
based on the market approach is 0.5 times the revenue.
• We can apply this multiple to the subject business's revenue to
estimate its value after making necessary adjustments for
differences between the subject business and the comparable
transactions.

15.

Income
Approach
The income approach to business valuation is based on the present value of
future cash flows that the business is expected to generate. It is a popular
approach for valuing businesses that have a history of stable or growing cash
flows.
Here are the steps to use the income approach for business valuation with an
example:
• Project future cash flows: The first step is to estimate the future cash
flows that the business is expected to generate. This involves analyzing
historical financial statements, current market conditions, and growth
prospects. For example, let's say a company generates a net cash flow
of $100,000 per year and is expected to grow by 5% per year for the
next 5 years.
• Determine the discount rate: The discount rate is the rate of return
that investors require for the level of risk associated with the
investment. This rate is determined by assessing the risk of the
business and market conditions. For example, let's say the discount
rate for this business is determined to be 10%.
• Calculate the present value: The present value of future cash flows is
calculated by discounting the future cash flows to their present value.
The formula for present value is: Present value = Future cash flow / (1 +
discount rate) ^ number of years. For example, the present value of the
cash flow in year 1 is $90,909 ($100,000 / (1 + 10%) ^ 1).

16.

Income
Approach
• Calculate the terminal value: The terminal value is the
estimated value of the business at the end of the projection
period. This can be calculated by applying a multiple to the
projected cash flows in the final year. For example, let's say the
multiple is 5x and the cash flow in year 5 is projected to be
$125,000. The terminal value would be $625,000 (5 x
$125,000).
• Determine the total present value: The total present value is
the sum of the present value of future cash flows and the
terminal value. For example, the total present value would be
$954,115 (($90,909 / (1 + 10%) ^ 1) + ($95,294 / (1 + 10%) ^ 2)
+ ($100,059 / (1 + 10%) ^ 3) + ($105,062 / (1 + 10%) ^ 4) +
($625,000 / (1 + 10%) ^ 5)).
• Adjust for any additional factors: Finally, the total present
value is adjusted for any additional factors that may impact the
value of the business, such as debt, outstanding litigation, or
changes in the market. For example, let's say the business has
a debt of $50,000. The adjusted total present value would be
$904,115 ($954,115 - $50,000).

17.

The asset
approach
• The asset approach is a business valuation
method that estimates the value of a company
by assessing its tangible and intangible assets.
This approach is often used for businesses with
significant assets, such as real estate or
manufacturing equipment, and is less common
for service-based companies.
• Overall, the asset approach is a useful method
for valuing companies with significant tangible
and intangible assets. However, it may not be
the most appropriate method for service-based
businesses or companies with limited assets.

18.

The asset
approach
steps
Identify the company's tangible assets: Start by compiling a list of the company's
tangible assets, such as land, buildings, equipment, and inventory. Determine the fair
market value of each asset, either by using appraisals or by researching similar assets on
the market. For example, a manufacturing company's tangible assets might include a
factory building, machinery, and raw materials inventory.
Identify the company's intangible assets: Next, consider the company's intangible
assets, such as patents, trademarks, and customer lists. Determine the fair market value
of these assets based on market research or appraisals. For example, a software
company's intangible assets include proprietary software, patents, and trademarks.
Subtract the company's liabilities: Subtract the company's liabilities from the total value
of its tangible and intangible assets to determine its net asset value. For example, if a
manufacturing company's tangible and intangible assets are worth $5 million and its
liabilities of $2 million, the net asset value would be $3 million.
Adjust the net asset value: Adjust the net asset value to account for factors such as
depreciation, obsolescence, or outstanding legal issues that may impact the value of the
assets. For example, suppose a company has equipment nearing the end of its useful
life. In that case, its fair market value may be lower than its original purchase price, and
the net asset value should be adjusted accordingly.
Consider the company’s future earning potential: Finally, consider its future earning
potential in relation to its net asset value. This will help to determine whether the assetbased valuation is reasonable or if additional adjustments need to be made. For
example, suppose a manufacturing company’s net asset value is $3 million but has a
strong industry reputation and a history of consistent profits. In that case, it may be
worth more than its asset value alone suggests.

19.

Nonquantitative
Factors in
Valuing a
Business
• Competition
• Market
• Future Community
Development
• Legal Commitments
• Union Contracts
• Buildings
• Product Prices

20.

Placing a
Value on a
Service
Business
The biggest asset of a service
company is its employees, including
senior management, followed by
customers and the business system.
The value of a service company is
found in the quality of the relationship
between its management (staff) and
customers. Without those
relationships, there is no business.

21.

Possible
Conditions
on the
Purchase
of a
Service
Business
The owner must stay on as an employee
for two years, an employee for one year,
and a consultant for two more.
Any loss of an account or a large
customer in place at the sale’s closing
will reduce the payout by some defined
amount.
One-third of the total purchase price will
be paid at closing. The remainder will be
paid in equal payments over three years.

22.

Calculate
your
business
worth
• Go to https://www.bizex.net/business-valuation-tool or scan the
QR Code
• Give details of your business from your financial forecasts
• Give determinants of multiple of earnings and select your risk
factors
• Get your business value and compare it with its valuation by assets