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business valuation

Page history last edited by Brian D Butler 13 years, 7 months ago

 

 

 

 

 

Table of Contents:


 

 

Business valuation 

 

Businesses or fractional interests in businesses may be valued for various purposes such as mergers and acquisitions, sale of securities, and taxable events. An accurate valuation of privately owned companies largely depends on the reliability of the company's financial information. One of the most popular methods for valuing a business is to take the net present value of its expected future cash flows.

 

 

Financial Modeling:

 

The key tool in calculating the value of a company is to conduct thorough analysis.  The technique is called Financial modeling.  Please visit this page for more information.

 

 

 

Venture Capitalists and Valuations 

 

 

 

Venture Capital - model

This is a hypothetical (unrealistic) situation, but will be used for an example.

 

VC valuation method 01-1.xls

 

 

Valuations and Internet Companies

 

Valuing internet start up companies is tricky business.  click here for more discussion:

Valuations and internet companies 

 

 

Some tools

 

Here is a nice tool for estimating the value of your startup:

  • http://www.liquidscenarios.com/  By far the best software Ive seen so far:  Liquid Scenarios provides software that estimates valuations of private companies, and determines the benefits or outcomes of liquidation events versus financings for all parties involved.
  • Valuation Estimator - excellent for high tech startups (not just for internet, but for all companies raising money).
  • http://younoodle.com/predictor  This is a fancy algorithm.   The value is understanding how VCs try to put a value on future worth of a start up.  Take the numbers with a grain of salt, though, because its still just a bunch of guess work, based heavily on the managment team, past success, etc...
  • http://pedatacenter.com/pedc/ Fee = $325 per month.  " venture-backed company valuations and the venture capital deal terms used to reach those valuations!"

 

 

Many Valuation Techniques:

 

Book Value

 

value vs. cost - when accountants talk about "book value" of assets, they are actually talking about the historical cost of those assets, which might be significantly different from the actual market value.  For example, assets on the balance sheet are recorded by what the owner originally paid for them, and not what they would trade for in the market today.  In many cases, the assets are actually much more valuable than the book cost indicates.  

 

Investors use the balance sheet want to know the value of the firm, not its cost.  This implies that they must use their judgement when valuing a firm because much of what a firm is valuable for is not included on the balance sheet, such as management skill, or trademarks (such as McDonald's), etc.

 

Note: book value is what the firm is worth "dead", but investors want to know what the firm is worth alive, and so investors often look at ratios such as Market / Book ratio which compares the market value of the firm vs. the book value of the firm. 

 

 

Real Options:

Using "options" analsis to value startup companies.  This technique was very popular duing the internet booms.  See our discussion on real options:  an important technique for valuing uncertain projects with high risk projects

 

 

Assume perpetual dividend

 

If you assume a perpetuity, then the valuation is very simple.  The formula is just PV = C / r,  where C = the cash flow into perpetuity, and the r = the discount rate.   So, if you know that a firm is going to pay out a constant dividend for ever, that is your cash flow as an investor.  The value of the firm is calculate by dividing that dividend (cash flow) by the appropriate discount rate.

 

But, most companies grow over time..... not problem, then just assume a perpetual dividend payment with growth.  The formula is still simple, its just  PV = C / r-g,  where g = the growth.  So, if you know that a company will always pay out a dividend and that the dividend will grow by x% per year,then just subtract the r-g to find the (lower) new discount rate, and divide.  The result is the PV of that expected future cash flow.  But, be careful when assuming a growing perpetuity, and dont assume that it will eventually grow so big that it is unrealistic.

 

If the firm pays out all earnings per share (EPS) as dividends, then PV = EPS / r = Dividend / r.

 

But, is it really realistic to assume that a firm will pay out all of its earnings as dividends?  No.  It is especially not realistic for firms in high-growth areas in which it is wise for a firm to re-invest its earnings into additional capital budgeting projects (note that google has never paid out dividends to shareholders).  Shareholders of high growth firms expect the firm to reinvest the earnings into further profitable projects.  But, if the firm does not pay out dividends, then how do you value the firm?   The answer is that you still use the EPS / r, but then you also add a factor to account for the growth options (NPVGO)

 

(EPS / r)  +  NPVGO,   where NPVGO = "net present value of growth options", and is the additional value that the firm gets because it reinvests its earnings.  So, in order to create value by reinvesting the earnings, the firm must select projects that have positive NPV. 

 

Make sure you discount dividends and not earnings.

 

But, what about the no-dividend firm?  If the firm pays out no dividends, then this method of valuation becomes much more difficult, and another method should be selected.... see:  Venture Capital Method of Valuation, and Angel investor valuation method, and Valuations and internet companies

 

 

 

Multiples method - EBITDA,  PE ratio, etc...

 

A method for determining the current value of a company by using a sample of ratios from comparable peer groups. The specific ratio to be used depends on the objective of the valuation. The valuation could be designed to estimate the value of the operation of the business or the value of the equity of the business.

 

Which ratios to use?

EBITDA multiple:  EBITDA / EVA...

 

When calculating the value of the operation the most commonly used ratio is the EBITDA multiple, which is the ratio of EBITDA (Earnings Before Interest Taxes Depreciation and Amortization) to the Enterprise Value (Equity Value plus Debt Value).

 

Price Earnings Ration (PER):

 

When valuing the equity of a company, the most widely used multiple is the Price Earnings Ratio (PER) of stocks in a similar industry, which is the ratio of Stock price to Earnings per Share of any public company. Using the sum of multiple PER’s improves reliability but it can still be necessary to correct the PER for current market conditions.

 

P/E Ratio:

 

A method for determining the current value of a company by examining and comparing the financial ratios of relevant peer groups. The most widely used multiple is the price-earnings ratio (P/E ratio) of stocks in a similar industry. Using the average of multiple PERs improves reliability but it can still be necessary to correct the PER for current market conditions

 

 

Discounted cash flows method 

 

see our discusson on DCF valuation

 

 

BOOK VALUE :

Is simply the business valuation based upon the accounting books of the business. Assets less liabilities equals the owners equity, which is the "Book Value" of the business. The problem with book value business valuation methods is that the accounting records may not accurately reflect the true value of the assets in the business valuation.

 

value vs. cost - when accountants talk about "book value" of assets, they are actually talking about the historical cost of those assets, which might be significantly different from the actual market value.  For example, assets on the balance sheet are recorded by what the owner originally paid for them, and not what they would trade for in the market today.  In many cases, the assets are actually much more valuable than the book cost indicates.  

 

Investors use the balance sheet want to know the value of the firm, not its cost.  This implies that they must use their judgment when valuing a firm because much of what a firm is valuable for is not included on the balance sheet, such as management skill, or trademarks (such as McDonald's), etc.

 

Note: book value is what the firm is worth "dead", but investors want to know what the firm is worth alive, and so investors often look at ratios such as Market / Book ratio which compares the market value of the firm vs. the book value of the firm. 

 

 

 

ADJUSTED BOOK VALUE VALUATION METHODS:

Your MBA performs two types of adjusted book value business valuation: Tangible Book Value and Economic Book Value (also known as book value at market).

 

Tangible Book Value business valuation is different than book value in that it deducts from asset value intangible assets, which are assets that are not hard (e.g., goodwill, patents, capitalized start-up expenses and deferred financing costs).

 

Economic Book Value business valuation allows for a value analysis that adjusts the assets to their market value. This business valuation allows valuation of goodwill, real estate, inventories and other assets at their market value.

 

 

INCOME CAPITALIZATION VALUATION METHODS:

First you must determine the capitalization rate - a rate of return required to take on the risk of operating the business (the riskier the business, the higher the required return). Earnings are then divided by that capitalization rate. The earnings figure to be capitalized should be one that reflects the true nature of the business, such as the last three years average, current year or projected year. When determining a capitalization rate you should compare with rates available to similarly risky investments.

 

 

DISCOUNTED EARNINGS:

This determines the value of a business based upon the present value of projected future earnings, discounted by the required rate of return (capitalization rate). Usually, the question is how well earnings are projected.

 

 

PRICE EARNINGS MULTIPLE:

The price-earnings ratio (P/E) is simply the price of a company's share of common stock in the public market divided by its earnings per share. Multiply this multiple by the net income and you will have a value for the business. If the business has no income, there is no business valuation. If the common stock in not publicly traded, business valuation of the stock is purely subjective. This may not be the best choice of business valuation methods, but can provide a benchmark business valuation.

 

 

DIVIDEND CAPITALIZATION:

Since most closely held companies do not pay dividends, when using dividend capitalization valuators must first determine dividend paying capacity of a business. Dividend paying capacity based on average net income and on average cash flow are used. To determine dividend paying capacity, near term capital needs, expansion plans, debt repayment, operation cushion, contractual requirements, past dividend paying history of a business and dividends of a comparable company should be investigated. After analyzing these factors, percent of average net income and of average cash flow that can be used for the payment of dividends can be estimated. What also must be determined is the dividend yield, which can best be determined by analyzing comparable companies. As with the price earnings ratio method, this usually produces a subjective result.

 

 

SALES MULTIPLE BUSINESS VALUATION METHODS:

Sales and profit multiples are the most widely used business valuation methods benchmark used in valuing a business. The information needed are annual sales and an industry multiplier, which is usually a range of .25 to 1 or higher. The industry multiplier can be found in various financial publications, as well as analyzing sales of comparable businesses. This method is easy to understand and use. The sales multiple is often used as the business valuation benchmark.

 

 

PROFIT MULTIPLE BUSINESS VALUATION:

Profit and sales multiples are the most widely used business valuation benchmarks used in valuing a business. The information needed are pretax profits and a market multiplier, which may be 1, 2, 3, or 4 and usually a ceiling of 5. The market multiplier can be found in various financial publications, as well as analyzing the sale of comparable businesses. These business valuation methods are easy to understand and use. The profit multiple is often used as the business valuation ceiling benchmark.

 

 

LIQUIDATION VALUE:

This type of business valuation is similar to an adjusted book value analysis. Liquidation value is different than a book valuation in that it uses the value of the assets at liquidation, which is often less than market and sometimes book. Liabilities are deducted from the liquidation value of the assets to determine the liquidation value of the business. Liquidation value can be used to determine the bare bottom benchmark value of a business, since this should be the funds the business may bring upon business valuation.

 

 

REPLACEMENT VALUE:

This type of business valuation is similar to an adjusted book value analysis. Replacement value is different than liquidation value in that is uses the value of the replacement value of assets, which is usually higher than a book valuation. Liabilities are deducted from the replacement value of the assets to determine the replacement value of the business.

 

 

TRUE VALUE BUSINESS VALUATION:

Is the amount that a buyer is finally willing to pay. This is the "real world" in business valuation methods.

 

 

Monte Carlo Valuation method:

Monte Carlo methods in finance are often used to calculate the value of companies, to evaluate investments in projects at corporate level or to evaluate financial derivatives. The Monte Carlo method is intended for financial analysts who want to construct stochastic or probabilistic financial models as opposed to the traditional static and deterministic models.

 

 

Links from KookyPlan

 

 

Pages names with "Venture Capital"

 

 

Private Equity

 

 

More related links:

 

 

 

 

Tools for investors

 

Investment Analysis

 

Valuation

 

 

 

 

Documents for further Research:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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