Understanding Business Valuation Techniques

Determining the value of a business, whether you’re selling or acquiring, is a critical component of the mergers and acquisitions process. From financial performance and market conditions to trends and benchmarks, business evaluation involves in-depth analysis of many factors to reflect both the company’s perceived and intrinsic value accurately.

Understanding business valuation techniques is crucial for both the seller and the buyer, and here, we’ll cover five popular methods.

1. Comparable Company Analysis

Often referred to as “comps,” a comparable company analysis (CCA) is when a business is evaluated by comparing it to similar companies in the same industry. A range of financial metrics are analyzed, including:

• Enterprise value-to-EBITDA (earnings before interest, tax, depreciation & amortization)
• Price-to-earnings ratio (P/E)
• Price-to-sales ratio (P/S)

The great thing about a CCA is that data is typically readily available and reflects current market conditions. A challenge, however, can be choosing appropriate companies to compare the business to.

2. Discounted Cash Flow Analysis

This business valuation technique compares a company’s potential future value to its present-day cash flow.

With a discounted cash flow analysis (DCF), if a business is projected to be worth a substantial amount of money, say, five years from now, the appraiser takes that projected value and works backward to determine the present-day worth.

While a DCF analysis can help provide a more thorough understanding of a company’s intrinsic value, it does operate on assumptions. The projected future value is hypothetical. While the value is based on data and the market, it is still an assumption about how the market will play out.

3. Precedent Transactions Analysis

A PTA is a market-based approach that uses past transactions of similar mergers and acquisitions deals. This technique assumes you can infer a business’s value using historical data.

This is an excellent technique for businesses in which similar companies operate in the same industry and geographic area. A comparable business that sells in a different state isn’t likely to provide valuable data that can be applied to the company.

It’s also important to note that if a past transaction may not accurately reflect current market conditions, be cautious when utilizing a precedent transaction analysis from an older deal.

4. Asset-Based Valuation

An asset-based technique focuses on the value of a company’s assets minus its liabilities. Within this technique, there are typically two approaches:

• One approach is operating assuming the business will continue to operate.
• The second approach assumes the business will be liquidated or sold off.

This valuation technique particularly benefits businesses with significant physical or financial assets. However, it may not be the best valuation approach for those that don’t and instead have more intangible assets like brand value or intellectual property.

5. Market Capitalization

One of the more simple valuation techniques is market capitalization, which is found by multiplying the number of outstanding company shares by the market value of one share. The resulting number is often a starting point from which to work, but, as you can see, this method only applies to publicly traded companies.

Secure a Fair Price for Your Deal

As the #1 business mergers and acquisitions firm in the country, our team is here to help you secure or exit a company at the fair price you deserve. Connect with Len Washko, our Business Price Opinion Advisor, to learn more about the actual value of your next opportunity.