To properly prepare for the sale of your business or work on an acquisition project, you need to look at its valuation. Many business valuation methods exist: the asset approach, the cash flow method, the comparative system, performance-based methods, the scale method, etc. In this file, we present to you the main methods of business valuation, the choice of the valuation method, and the adjustment of the amount calculated according to essential criteria.
The Different Business Valuation Methods
There are many possible valuation methods to assess the sale price of your business. Here, we will introduce you to the following four main ways:
- Asset assessments
- Performance-based assessments
- Valuations based on free cash flow
- Evaluations using a comparative approach
- Evaluations by scale
Depending on your situation, it is then necessary to select one or two suitable evaluation methods and then adjust the amounts obtained according to the criteria deemed necessary. As we mentioned in our special report dedicated to preparing for a business sale, the evaluation stage is essential. However, it simply allows you to obtain an idea of the value of your business; the final sale price will then be agreed upon in negotiations with the buyer.
Promote Your Business With The Heritage Approach
The asset valuation method consists of separately evaluating each of the elements of assets and liabilities (debts and provisions for risks and charges) recorded in the company’s balance sheet to obtain a corrected and revalued “net asset” corresponding to the value of society. Valuation of each item is essential since book values often do not reflect the actual value of an asset or liability, so they must be reassessed. To apply the method with relevance, it is necessary to remember the suitable evaluation methods.
Valuing Your Company Based On Its Performance
The evaluation of the transfer price carried out based on the performance of the company consists of applying a percentage or a figure to a performance indicator. For example, we can use financial indicators such as commercial margin, added value, gross operating surplus, profit, etc.
For certain activities, the evaluation of the sale price of the company can be worked on based on a critical indicator of the company’s activity. This could, for example, be the number of subscribers for a store publishing company, the number of pages viewed or the audience for a company that publishes websites, the production volume for a company that manufactures a product or a material, etc…
Valuing Your Business With The Free Cash Flow Method
This method, also called the “DCF method,” involves estimating the market value of a company by adding the discounted after-tax free cash flow to the required rate of return for investors and then subtracting the value of net debt. Free cash flow is calculated as follows:
- Free cash flow = Gross operating surplus – Theoretical corporate tax on operating income – Change in working capital – Investments net of divestments.
This evaluation method is based on the future performance of the company over several years. The cash flows are calculated on forecast data and, therefore, assumptions. As a precaution, several scenarios must be planned. The choice of duration and discount rate is complex and decisive for the valuation of the company.
The free cash flow valuation method has the advantage of being based on the future of the company rather than its past and its future profitability rather than its asset values. On the other hand, the application of this method is susceptible to the assumptions made. The forecasts must be made over a relatively long period in order to be able to perform the calculations. It is preferable to be accompanied by an accountant or a specialist in business transfer when using this complex technique. This method is explained in detail on the Compta-Facile website: The DCF method.
Valuing Your Business With The Comparative Approach
The comparative approach consists of valuing your company in relation to a sample of comparable companies, which must have the same sectoral, geographical, and operating characteristics. It is also possible to rely on recent sales of similar companies. To determine a valuation, you must, therefore, find several companies similar to yours as well as their sale price or their value (when they have not been sold).
Your price must then be adjusted according to several criteria deemed necessary in relation to your activity (see here). The advantage of this method is to offer a transfer price consistent with the current market. However, the application of this method is only possible in the presence of comparable companies nearby.
Value Your Business Based On Scales
Small businesses are often valued using percentage scales of turnover, which experts and courts use. This method provides an assessment of the transfer price, which does not take inventory into account. You must be careful with this approach because it does not reflect the profitability of the business and needs to take into account the location of the company, its notoriety, the state of its production tools, and its premises. … The scale approach provides an idea of the average sale price of companies in the same sector.
Adjusting The Valuation Based On Importance Criteria
Then, the first evaluations carried out with the methods you have selected must be adjusted, taking into account several critical criteria. These essential criteria combine both general criteria and criteria that depend on the activity you carry out. Here are some examples of general criteria:
- ongoing litigation may reduce the valuation,
- a loyal and diversified customer base can increase valuation,
- the importance of the manager’s relationships in the activity can reduce the valuation,
- …
Here are some examples of criteria linked to the activity carried out:
- for production companies: the state of the production tool and any elements to be replaced,
- for local stores: the condition and location of the premises.
How Do You Choose Among All These Valuation Methods?
Each of the methods presented above has its advantages and disadvantages, so you need to identify which ones are best suited to your case. To do this, we advise you to take stock with your accountant or a business transfer professional. In practice, for transfers of VSEs/SMEs, we generally use the comparative approach and the evaluation by scale to evaluate a transfer price. Then, some methods are recommended by the sector of activity, so you need to find out about this.
In all cases, we advise you to retain the comparative approach evaluation among your selected methods in order to be consistent with the current market. Potential buyers who are looking for a target will compare several similar companies for sale before making their choice (in the same way as in the real estate market).
A sale price higher than the average market price reduces your chances of finding interested buyers. The results resulting from the valuation of your company remain theoretical. The actual sale price will be determined according to the opportunities available to you and the negotiations that you will carry out with the buyers.
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