Project Description

Every entrepreneur should know what their business is worth and how to determine what an organization they are looking to potentially buy is worth. Business valuation is a process and a set of procedures used to estimate the economic value of an owner’s interest in a business. Valuation is used by financial market participants to determine the price they are willing to pay or receive to effect a sale of a business. This course is designed to provide you with the basic means of determining business value.

You can start determining the value of an organization by looking at their assets. What does the business own? What equipment? What inventory? After all, you’d have to buy all the same stuff if you were starting that business from scratch, so the business is worth at least the replacement cost of those items. Warren Buffett uses what’s called a discounted cash-flow analysis. He looks at how much cash the business generates each year, projects it into the future and then calculates the worth of that cash flow stream “discounted” using the long-term Treasury bill interest rate.

There are a lot of equations and methodologies typically used to value a business. There’s no “right” way, though you could probably come up with several wrong ones. Ultimately, the business is worth whatever you think it’s worth, based on the criteria you set forth and the metrics you determine matter the most. Check out the video below on how Warren Buffet calculates the intrinsic value of a business.

Most valuation approaches treat businesses as a stream of cash. They value a business by trying to come up with a value for that stream of cash, which is usually defined as it’s revenue. Revenue is the crudest approximation of a business’s net worth. For example, if a business sells $100,000,000  in products per year, you can think of it as a $100,000,000 revenue stream, however, businesses are often valued at a multiple of their gross revenue. The multiple depends on the industry and is usually expressed in terms of “two times sales” or “one times sales.”

Any seasoned entrepreneur will tell that revenue doesn’t equal profit. For example, how would you value a business that had $4 billion in gross revenue annually, but required a cash investment of $380 million per year just to keep it afloat? To help you make sense of it all, the following valuation idiosyncrasies will be discussed in our course: 

No matter which methodology is used, every business valuation has certain elements to them. We will touch upon the elements typically used in the United States, which are economic conditions, financial analysis, normalization of financial statements, and valuation approach (typically, income, asset, or market).

The income approach relies upon the economic principle of expectation: the value of business is based on the expected economic benefit and level of risk associated with the investment. Income based valuation methods determine fair market value by dividing the benefit stream generated by the subject or target company times a discount or capitalization rate. The discount or capitalization rate converts the stream of benefits into present value. There are several different income methods, including capitalization of earnings or cash flows, discounted future cash flows (“DCF”), and the excess earnings method (which is a hybrid of asset and income approaches). The result of a value calculation under the income approach is generally the fair market value of a controlling, marketable interest in the subject company.

In the asset-based approach the valuation of a business, the organization in question is equal to the sum of its parts. That is the theory underlying the asset-based approaches to business valuation. The asset approach to business valuation is reported on the books of the subject company as their acquisition value less depreciation, where applicable. These values must be adjusted to fair market value wherever possible. The value of a company’s intangible assets, such as goodwill, is generally impossible to determine apart from the company’s overall enterprise value. For this reason, the asset-based approach is not the most probative method of determining the value of going business concerns.

The market approach to business valuation is rooted in the economic principle of competition: that in a free market economy, supply and demand forces will drive the price of business assets to a certain equilibrium. Buyers would not pay more for the business, and the sellers will not accept less, than the price of a comparable enterprise. The buyers and sellers are assumed to be equally well informed and acting in their own interests to conclude a transaction. It is similar in many respects to the “comparable sales” method that is commonly used in real estate appraisal.

The valuation approaches yield the fair market value of the Company as a whole. In valuing a minority, non-controlling interest in a business, however, the valuation professional must consider the applicability of discounts that affect such interests. Discussions of discounts and premiums frequently begin with a review of the “levels of value”. There are three common levels of value: controlling interest, marketable minority, and non-marketable minority.

There are several other methods for determining the value of an organization. Although valid, we will not focus much time on these, but rather introduce you to them so you have a glancing familiarity with them, such as the Guideline Public Company Method.

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CRAIG CANDELORE, ESQ.Company Valuations
Mr. Candelore served five years on active duty as an Army officer after graduating from the U.S. Military Academy at West Point in Engineering. Leaving active duty, he graduated from the University of San Diego School of Law Cum Laude in 1984. After law school, he concluded his Masters in Systems Management at the University of Southern California. Craig established his own family law firm in downtown San Diego where he has served the community ever since supervising four attorneys and nine staff.

He served in the Army Reserves reaching the rank of Colonel before retiring in 2008. Assignments have included: Senior Regional Army Reserve Law Enforcement and Anti-Terrorism Officer for the tri-states of California, Nevada and Arizona. When called to active duty, he deployed in the service of his country for both Operations Desert Storm and Iraqi Freedom (OIF). In OIF, he was in charge of Iraqi Police Development. He received the combat action badge and awarded the Bronze Star. Craig founded the non-profit Honoring Our Troops which addresses veteran legal needs via a monthly legal clinic and seminar.

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