How to value a business for sale or purchase

There are thousands of reasons for your decision to buy a ready business or sell your own. But in any case, you will always ask yourself the question “How much does it cost? What is the correct price?"

Starting to think about the price — and there are more questions. How to calculate the cost of a business for sale? Or how accurate is the price requested by the seller? How to formulate and justify the maximum price that can be obtained in the sale? How does this price correspond to the market? Or — in case of purchase — how not to overpay?

Each business is unique, and it is almost impossible to determine its value simply by looking at offers on the market — There are no identical offers. In practice, given the limited range of buyers, the amount that a business owner requests and the amount that he ultimately receives can differ significantly.

What does business valuation give to its seller and buyer?

So, it is clear that a business valuation is required — that is, determining its market value. It will not only give you an idea of the real value of the object of purchase or sale, but also arm you with arguments in negotiations.

What does the seller get when assessing the value of a business?

1. Information about the real value and liquidity of its assets.
2. Orientation in the economic situation of the company and the ability to build a pre-sales plan.
3. Identification of existing problems that affect the financial condition of the business, as well as display possible risks, including those affecting its value.
4. Market monitoring. That is, information about what place the company occupies in the market. The owner can evaluate his business periodically to observe the dynamics.

What does the buyer get when assessing the value of a business?

1. An assessment of the state of the business and the dynamics of change in this state.
2. Key benefits and risks of entering the industry. Their managerial and financial assessment.
3. Business prospects (assessment of the attractiveness of its field of activity and markets, the availability and qualifications of personnel, the availability of contracts and customer base, etc.).
4. Indicators for planning the further development of the purchased business.

How to calculate the value of a business in an appraisal?

You can evaluate the value of a business, regardless of the form of ownership, based on 3 basic valuation approaches:

1. Income Approach to Business Valuation

At the heart of this — business income. It depends on them how much the object of sale will cost in the end. The more money a company brings in, the higher its price. The expert assesses how much the “income is worth” now, which the owner will be able to receive in the future in case of successful operation of the company or sale, as well as the economic risks associated with this process.

The income approach is used when the reason for valuing a business is the desire to sell a profitable company or attract investments in it. As a rule, any investor or potential buyer is ultimately interested not in a building equipped with equipment that produces a promoted and recognizable product, but in the amount of income that he will receive when he invests in the development or purchase of assets. Income determines profit, business efficiency and the well-being of its owner.

Future earnings are brought to present value in a variety of ways. It depends on the method chosen by the appraiser. The income approach includes the following methods:

• Direct capitalization method. The market value of a business is estimated using the formula V=D/R, where D — net annual income of the company, R — capitalization ratio. To calculate, you need to know the amount of income for a period of time ahead. The method is suitable for companies that demonstrate stable and predictable growth, and there is a high probability that profitability will be maintained in the future.
• Method of discounting the expected cash flows of income. In this case, the expert discounts the future flow at the discount rate. At the heart of the — the economic fact that the amount of money we have now is really worth more than the same amount of money in the future. There are several reasons for this — from inflation to force majeure. The expert who makes the valuation must estimate the future flows and correctly calculate the discount rate. Discounting is often used in cases where it is predicted that the company's profit over a period of time will differ from the current one. Another case: when cash flows are seasonal. The method is also effective for evaluating large multifunctional commercial facilities.

The benefits of this approach:

Takes into account investment expectations and economic depreciation of the business being valued. Allows you to estimate future income, taking into account the situation on the market.

Weaknesses:

Based on of this — predictions, not hard facts. There may be errors in the calculation of the discount rate due to incomplete data and lack of stability in the economy.

The income approach is often used in practice. However, it is not the only correct one. In order to get the most accurate result, it is worth applying other approaches to business valuation.

2. Cost approach to business valuation

The cost approach is based on the idea of spending. It involves the use of methods based on the determination of the cost of reproduction or replacement of the object of assessment, taking into account depreciation and amortization. It is usually used in cases where the business does not generate stable income. For example, a company has recently been created or is in the process of liquidation. Experts determine the market value of each asset separately, and then subtract the amount of the company's liabilities from the total assets. This is how equity is obtained. This approach allows you to calculate the most efficient method of using land and evaluate construction in progress. This approach to business valuation includes two methods:

• Net Asset Method. Experts determine the market value of a company's assets and then subtract its liabilities. Adjustments are made not to the income and expenses of the company, but to the balance sheet items.
• Liquidation value method. In this case, the amount that the owner will receive if he liquidates the business and sells the assets separately is calculated. Here, goodwill (goodwill — an intangible asset of a company that reflects its business reputation in the market) is not taken into account, but dismantling costs, commission payments to intermediaries, taxes on property sales and a number of other expenses are taken into account.

The benefits of this approach:

It is most reliable when evaluating new objects. Suitable for entrepreneurs who focus on construction, rather than the purchase of a finished facility. Allows you to evaluate how efficiently land is used.

Weaknesses:

Costs are not always equivalent to the market value of objects. It is difficult to calculate the cost of reproducing obsolete buildings. Land has to be valued separately from structures. The calculations do not take into account the prospects for the development of the enterprise. The cost approach methods are quite difficult to apply in practice.

3. Comparative approach to business valuation

At the basis of the calculations of the comparative approach, the appraiser puts information about companies that are as similar as possible to the one being evaluated. How accurately the cost will be set depends on the reliability of information about competitors. The value of a business is focused on the amount for which you can sell a similar business that already exists on the market. This approach is not often used, because it is not so easy to find two absolutely identical businesses in the market.

The comparative approach relies on three methods:

• The capital market method. The — prices formed in the stock market. When calculating the value of the company's shares, the appraiser focuses on the value of one share of the company-analogue.
• Deal method. Similar to the previous one. The only difference is that the price of not one share, but the controlling stake as a whole, is subject to research.
• Industry coefficient method. Experts calculate the ratio between the value of a business and a set of financial parameters. In this case, information is required on the conditions under which companies with certain financial and production indicators were sold. Here we are talking about long-term observation, which eventually allows us to develop fairly simple formulas for valuing the company's assets. The coefficients are universal and mostly depend only on the specifics of the industry.

The benefits of this approach:

This approach is based on reliable information, reflects the real results of the company. Shows the amount of supply and demand for a particular object, taking into account the market situation.

Weaknesses:

The calculation is based on the analysis of the past. Therefore, the potential of the enterprise is not taken into account. The calculations are quite laborious, with a large number of adjustments. Methods are effective only if there is extensive financial information on a particular business and its analogues.

All these approaches are related to each other, but at the same time they rely on different aspects of the business and market being assessed. Therefore, it is wiser to use them in a complex. Ideally, the results obtained by each of the three approaches should be close to each other, but in fact the real conditions are such that this is practically unattainable. You need to choose the result that is more suitable for the characteristics of a particular business and the circumstances of the transaction.

Who should assess the value of a business?

We can safely say that buying or selling a — very complex and laborious process. And his assessment — key and no less difficult stage. Who is to do this work?

The first option that comes to mind is — let the seller evaluate the business. After all, he is familiar with all its details, being its owner, has invested a lot of time, effort, energy and even part of his soul into it. Alas, in practice this means that the estimate will always be overestimated. And not only because of the desire to get more money. But also because of the desire to compensate for costs, including intangible ones. How can you appreciate a part of your life? Of course, only expensive.

The downside of this option is that with the overpriced cost of selling a business, as a rule, it will take a very long time to find a buyer.

Another version of — the buyer will appreciate. But he is guided by the desire to pay less. And, of course, his price will also be subjective, besides, he does not know as much about the business he is buying as his owner.

So, both approaches suffer from subjectivity, which inevitably reduces the likelihood of a successful transaction.

Where is the exit? It consists in attracting specially trained people to the assessment — business brokers. Of course, they do not work for free and protect, first of all, the interests of the party to the transaction that hired them. But they are interested in the most objective assessment of the business, and they have their own reasons for this:

• An objective assessment provides negotiating arguments for the price. This means that the transaction is more likely to go through quickly and successfully, and the broker — get your commission;
• An objective assessment leads to greater satisfaction of both parties with the terms of the transaction;
• There are clear and stringent requirements of Federal Law N. 135 "On Appraisal Activities" that must be met so that the transaction is then not challenged and terminated in court.

In other words, boots should be made by a shoemaker, pies should be baked by a pieman, but businesses should evaluate and sell — business brokers. One of such professional teams operating in the international market, — this is Russian-Eurasian Business Broker (REAB).