Valuing Your Company

Establishing the company's value is fundamental to any corporate strategy initiative, whether that be establishing the baseline for market value enhancement consulting engagements, business sale, merger or acquisition planning, or founders' personal exit/financial planning.

In all cases, one needs to know what the company is worth.
 
In general, the value of a business is equal to the present value of the future benefits of ownership. The basic valuation process is illustrated by the pyramid below, reading from the bottom upwards.
 

Valuation Pyramid

 
Buyers acquire the continuation of a proven earnings stream (and/or projections); the business is what provides it.  Value is related to:
  • the ability of the business to generate an income stream meeting buyers' expectations (whether specific buyers or hypothetical buyers)
  • the risk of that not happening 

Tangible and Intangible Assets

Many companies have significant value tied up in tangible assets such as production equipment, vehicles, real estate or inventory. However, the primary value of a healthy, profitable, private company usually resides in the intangible assets such as the value of the trade name, reputation, vendor, distribution channel and customer relations, customer list, and so forth.
 
The difference between the sale price of a company and the fair market value of its tangible assets and liabilities is called "goodwill."   This difference indicates the ability of the intangible assets to earn profits, or value that cannot be assigned to the physical, tangible assets.  It is for this reason that companies with strong brands command a higher price than companies with weak brands.

Another way to consider goodwill is the "buy vs. build premium."  The goodwill amount represents the price premium for buying an existing company rather than starting a new one.  
 
The valuation process attempts to project a likely sale price for the company, including the fair value of its tangible assets + the projected goodwill value.

Internal and External Analysis and Risk Assessment

The following are only a few of the factors that will be considered when establishing a company's value. The market analysis is critical to forecast the risk of future earnings continuity, and multiple resources are employed to assess the industry.
  • Macroeconomics - The condition of the overall economy may have a profound effect on the value of your business. To illustrate, the value of a tourism-dependent business would be adversely affected by a downturn in the economy leading to a forecast of reduced tourism. The actual and forecast industry growth is very important, however your company's performance relative to competitors is at least as important. 
  • Patents, Proprietary Business Processes, Strong Brand - Items of this nature may have a profound effect on value, and may take special analysis to assess. 
  • Customer Concentration - Companies in which few customers account for a large proportion of revenue or profit present higher risk, as the loss of only one or a few customers may significantly reduce revenue and earnings.
  • Competitive Intensity - The competitive intensity of the market(s) in which your company competes has a direct bearing on profit potential.
  • Management Team - Having a trained management team that can run the business without the owner(s) day-to-day involvement adds value.
  • Historical Performance - Volatility and past growth are important considerations for buyers.

Valuation Approaches and Methods

To reach a conclusion of value, various methods are employed within the three approaches to valuing companies (Asset, Income & Market).
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