About Business Valuations

In our view, those are the basis on which to conduct a Fair Market Business Valuation. We will highlight the valuation methods and the assembly and calculation of those materials into a definative valuation.

Whether the purpose of the business valuation is to price the business ‘for sale’ or ‘for purchase’ the objective of the valuation should be the same; …to calculate its FAIR MARKET VALUE. That’s where agreement between reasonable buyer and reasonable seller will be found, and that’s where good businesses are bought and sold.

Fair Market Value … the amount at which a business will change hands …

  • from a reasonable Seller who is motivated, but not compelled to sell
  • to a reasonable Buyer who is motivated, but not compelled to buy
  • under terms and conditions acceptable to both
  • when both parties are in possession of, and have understanding of the relevant facts.

Seller Motivations: If the business is being valued for sale by a seller urgent to sell the business but for reasons unrelated to the viability and sustainability of the business, that urgency should probably not be calculated into the valuation. If the seller’s urgency is going to impact the price, it should impact the price later in the process, when the seller might decide to take less to get a deal done in order to satisfy the urgency. Thus, in conducting the valuation, one should assume the seller is motivated, but not compelled to sell.

Buyer Motivations: If the business is being valued for sale to a targeted buyer, motivations and compulsions may sometimes be gauged with some degree of accuracy, but typically, pricing a business for sale means pricing it for sale to a yet unknown buyer with yet unknown motivations and level of compulsion. Thus, in conducting the valuation, one should assume the buyer will be motivated, but not compelled to buy.

Terms and Conditions may include a host of considerations, but two primaries will be Payment Terms and Due Diligence. Will the purchase price be an all cash cash payment, or will the seller be prepared to carry a portion of the selling price; if so how much, over what period, at what interest rate and backed by what form of security. And, when it comes time for due diligence, what level of access will be available, and when, to the buyer with respect to books and records, employees, customers, suppliers, etc.

Relevant Facts: An absolute key to Fair Market Valuation, in our view, will be the availability to the valuator of the relevant facts pertaining to the business. These will include, and probably begin with the financial facts; the value of the hard assets of the business to be included in the sale, as well as the value of the soft assets of the business. Other considerations will include equipment condition or cost to rebuild or replace, continued availability of current location or availability of alternate facilities and cost to relocate, market conditions, economic conditions, transferability of the business to new ownership, employee relations and retention of key employees, customer and supplier relations and future probabilities, and more.

Some can and should be factored into the valuation. Some cannot, but will simply become part of the overall considerations of the buyer. And, the seller will have considerations as well and will want to know that the buyer is serious and capable and that ‘full payment’ will be received in due course, and will want to see facts in support of those matters, and all should be considered as a part of the ‘relevant factual’ requirements, although not a consideration of the business valuation per se.

Of course, there will be times when relevant facts may not be available, and times when much detail may not be required. But in our experience, other than very small businesses, or maybe start-ups or life style business, the occasions where neither buyer nor seller will care about these kinds of facts will be very few and far between. Thus, in conducting the valuation, one should assume that both buyer and seller will have access to all the facts material to the decision, and that they will understand the information or get help to understand it as they review or find it.

In our view, those are the basis on which to conduct a Fair Market Business Valuation. We will highlight the valuation methods and the assembly and calculation of those materials into a definative valuation, continuing on the next page.

There are several generally acceptable valuation techniques, each of which can be categorized by and large, as one of, or some combination of, or variation of three general methodologies.

  • Asset Cost Base method, based on replacement cost, or fair market value of included assets.
  • Income or Earnings Based method, which looks at the present value of future earning.
  • Market Comparison method, estimates the value of one business by comparing it to others.

In our experience, the value of a business has most consistently been calculated as “that amount which is equal to Balance Sheet Value plus Goodwill Value.”  The method employed in the calculation of that amount is a combination of asset cost and earnings based methods; asset cost with respect to balance sheet value and earnings based with respect to goodwill value.

In the valuation of small closely held businesses, the market comparison method has not really been a factor in any direct sense. The sale of really comparable small businesses located in truly comparable markets, and which have sold and supplied factually accurate and comparable ‘inside-the-deal’ information to someone collecting such data, are rare indeed.

While other industries, such as real estate perhaps, where, in terms size, style, construction type, neighbourhoods, etc., comparables are both available and meaningful, the business of buying and selling small businesses is confidential business and we have just not found an MLS of comparative information relative to the purchase and sale of small businesses.

So,… about the Balance Sheet Value plus Goodwill Value method that we do see employed.

Balance Sheet Value (asset cost based) is simply the net value of all the assets included in the valuation (and presumably the sale), minus the value of all the liabilities included in the valuation (and presumably the sale).  Balance Sheet Value is a measurement of a known quantity. The company balance sheet is a reflection of what the company ‘has earned and has retained and holds over until today’ from yesterday’s business, and balance sheet value is generally not a contentious calculation, particularly if they are valued at ‘book value.’

Often, in a small closely held business, certain assets will be excluded from the valuation (and from the sale), because they are ‘related party assets,’ such as a loan to a related party, or a vehicle driven by the business owner and which that owner wishes to retain, or perhaps the land and building may be excluded from the sale. And there may be others and often similarly, certain liabilities will be excluded as well and for similar reasons.  So Balance Sheet Value means Balance Sheet Value included in the valuation and presumably the sale.

Goodwill Value (earnings based) is a measurement of an unknown quantity, being an estimate of what the company ‘should earn or can be expected to earn’ from tomorrow’s business. Goodwill value is typically based on a multiple of normalized *ebitda; meaning *earnings before interest, taxes, depreciation, amortization.

*ebitda implies the recalculation of the company’s income statements so as to restate earnings before interest, taxes, depreciation, amortization and before the total of all forms of owner compensation (such as wages, salaries, dividends, benefits, perks and other beneficial accruals to the owner) that are in excess of what would otherwise be considered a reasonable market wage for the work-a-day job filled by the owner.  And, there may be other factors to adjust to business-norms or business-necessities as well, such as rents, vehicles, entertainment, charitable donations, etc., that may have been expensed at rates other than fair market or necessary to the business.

Discretionary Cash Flow must be sufficient to pay (or repay) the purchase price over a ‘reasonable time’ with a ‘reasonable return’ on investment, and thus cash flow becomes a regulator.

Valuation and selling price are regulated by the ability of sustainable levels of revenues to first satisfy all cost of sales, all operating expenses, taxes and debt service, and for discretionary cash left over thereafter to repay the purchase/sale price over a reasonable period of time, with a reasonable return on investment, and with a reasonable ‘rainy-day’ surplus or allowance for risk.

Arbitrary Components: But, valuation method accounts for part of the story. Reasonable value to one may not be to another, and reasonable time for one may not be for another. Purpose, motivations and compulsions of seller and buyer alike, and the type and degree and the value of strategic fit (if any) that may exist for one buyer and another are factors that may bring unique and legitimate weighting and suasion, and in the end different opinion.

Goodwill implies that ‘something from the past will gainfully continue into the future’ and goodwill valuation goes on to predict or estimate just what the continuing gain will be. Since no one knows the future, it’s obviously arbitrary and the best anyone can provide is a reasoned estimate. But, that being the best answer available, a ‘reasoned estimate’ is what is required and is what should be the objective of the valuation.

Thus, every business valuation that includes a goodwill component contains an arbitrary component, thus Fair Market Value will have an arbitrary factor as well, and consequently, the definition of fair market value contains flexibility.

Nevertheless, when buying/selling the business is the objective, and when valuation has been calculated in the manner outlined, and when buyer and seller are reasonable and reasonably motivated, we have generally found the arbitrary amounts to be resolvable.

In the foregoing, we have provided a brief overview of the valuation components based on our own experience. Then in pages to follow, in ValuPro1 we offer a PDF illustration of what has been explained above, and in ValuPro10, a more complete PDF explanation and illustration.

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About Us

davidsonashe was founded in 1996 as an affiliate member of the Business Brokers Network of more than 350 affiliated business intermediaries; business brokerage and consulting firms located across the United States and Canada. Locally, we have offices in Langley, BC and Lynden, WA and have been intermediaries instrumental in the sale of companies in northwest Washington and the British Columbia lower mainland since 1996.

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