What are the factors to consider when valuing a business?
In a previous article about the process of compiling a business appraisal, we noted that different factors are important in each of the three main valuation approaches—the market, income, and cost methods of valuation. But while there are a number of business valuation factors that can come into play, it’s important to recognize that not all of the factors affecting valuation are important in all cases.
In this article, we’ll examine various valuation factors and explain which factors are most important for different valuation scenarios.
Although it’s not traditionally recognized as a valuation factor, the most important determinant for any valuation is its purpose. In the factors that lead to a valuation of the company’s worth, the purpose of the valuation is the most important.
That’s because the purpose of the valuation establishes the premise of value. That value can differ if, for example, the purpose is investment in a stock rather than the sale of a business. Different purposes for valuation provide you with a guide for which business valuation factors will provide the most accurate estimate of value.
As an example, consider a valuation for an auto manufacturer. The most important business valuation factors will vary depending on what is being valued: the business enterprise, intellectual property (e.g. research and development), or its tangible assets, such as a manufacturing plant. If the focus is on the manufacturing plant itself, a ratio of analysis of earnings before interest, taxes, depreciation, and amortization (EBITDA) or revenue would need to be compared to a plant in a similar situation. The proper information can be difficult to obtain and a more reliable valuation factor would be the cost to replace or rebuild the plant itself.
Valuation experts think about valuation from a different perspective depending on its purpose. The broadest valuation can be thought of as a big box that contains smaller boxes that fit inside of it. This big box is the business enterprise—which includes smaller boxes of tangible and intangible assets, and the present value of future growth opportunities. The smaller boxes can also contain boxes which are smaller yet, which can be as small as individual physical assets, intellectual property (IP), or other intangible assets.
If the purpose is the sale of the business, certain parts of the business, or certain assets, the valuation expert will have different tools at his or her disposal. The purpose can change if the business is being sold to a third party or if a minority or majority shareholder decides to sell their shares in the company. In a private company, there will be variation in the value of a minority share vs. a majority share. The specifics of the case and the specifics of the parts of the business matter. What you look at and how you value it will depend on the purpose of the valuation and the factors that affect valuation for that purpose.
The next section focuses on the various factors to consider when valuing a business, and the cases where each is applicable.
Once the purpose for the valuation is understood, the various business valuation factors that are important for the specific case will be apparent. The following are the nine factors to consider when valuing a business. Depending on the purpose of the valuation, one or more of these factors may be immaterial:
As illustrated, the purpose of the valuation will determine the importance of each of the business valuation factors listed above. In business appraisal, purpose will always be the starting point in determining not only the valuation approach or approaches to use, but also how important each of these business valuation factors are in the valuation process. Professional business valuation specialists, like the team at Valentiam, will always begin by establishing the purpose of appraisal in order to determine the valuation methods and factors of greatest importance.
Valentiam has helped companies in a variety of industries attain accurate enterprise and asset valuations. We have extensive experience in the application of all valuation methods for a broad range of businesses and situations. Our valuation and transfer pricing specialists have worked with some of the largest companies in the world.
Contact us to see how we can help your company with your valuation and transfer pricing needs.