Tag Archives | business valuation

Business Valuation Purposes

See Also:
EBITDA Valuation
Valuation Methods
Multiple of Earnings

Business Valuation Definition

Business valuation is the process of determining the economic value of a business or company. It assesses a variety of factors to determine the fair market value in a sale, but there is no one way to verify the worth of a company. Business valuation can depend on the values of the assessor, tangible and intangible assets, and varying economic conditions. Business valuation provides an expected price of sale; however, the real price of sale can very.

Traditional approaches to business valuation employ financial statements, cash flow models, and comparisons to competitive companies within a similar field or industry.

Business Valuation Methods

Income Approach: determines business value based on income. This type of valuation focuses on net cash flow, discretionary cash flow, and capitalization of earnings.

Asset Approach: determines business value based on assets. This type of valuation focuses on asset accumulation (assets minus liabilities) and capitalized excess earnings.

Market Approach: determines business value in relation to similar companies. This type of valuation focuses on the comparative transaction method and appraises competitive sales of comparable businesses to estimate economic performance looking at revenue or profits primarily.

(Are you in the process of selling your company? The first thing to do is to identify “destroyers” that can impact your company’s value. Click here to download your free “Top 10 Destroyers of Value“.)

Business Valuation Purposes

Although the primary purpose of business valuation is preparing a company for sale, there are many purposes. The following are a few examples:

Shareholder Disputes: sometimes a breakup of the company is in the shareholder’s best interests. This could also include transfers of shares from shareholders who are withdrawing.

Estate and Gift: a valuation would need to be done prior to estate planning or a gifting of interests or after the death of an owner. This is also required by the IRS for Charitable donations.

Divorce: when a divorce occurs, a division of assets and business interests is needed.

Mergers, Acquisitions, and Sales: valuation is necessary to negotiate a merger, acquisition, or sale, so the interested parties can obtain the best fair market price.

Buy-Sell Agreements: this typically involves a transfer of equity between partners or shareholders.

Financing: a business appraisal is required before obtaining a loan, so the banks can validate their investment.

Purchase price allocation: this involves reporting the company’s assets and liabilities to identify tangible and intangible assets.
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Multiple of Earnings

See Also:
Normalized Earnings
Adjusted EBITDA
EBITDA Definition
Valuation Methods
Business Valuation Purposes

Multiple of Earnings

Multiple of earnings is one way to value a business. It involves multiplying a company’s profits by a certain number to end up with a value. “Multiple of earnings” multiplies the “earnings” (or income or profit) of a year, or average of years, in order to come up with a figure representing the company’s worth in a sale.

In most cases, EBIT (Earnings Before Interest and Taxation) is the amount used for this first earning’s number. However, for companies ranging from several million dollars to several hundred million dollars, the “multiple of earnings” is often equivalent to the multiple of EBITDA (Earnings Before Interest, Taxation, Depreciation and Amortization) instead of EBIT.

Determining what number the current profits are multiplied by depends on the stability of the business. For example, a company that’s very well-established, with a strong hold on the market, that can operate under or with an entirely new team might bring in a multiple of 8 to 10 times current profits. On the other end of the spectrum, a small, individualized business that relies solely on one service provider might acquire a multiple of 1 times current profits. In reality, most businesses are sold for a multiple of 3 to 5 times the current profits.

Using Multiple of Earnings for Business Valuation

There are many different methods for business valuation; however, the central method calculates multiple of earnings. You should consider some of the following questions before evaluating a company:

  1. Is a seller using pre-tax earnings or post-tax earnings? If you’re the buyer, remember to include your tax rate not the seller’s. If you are the one selling, pick which year of earnings to base the valuation on. Many sellers will use the current year’s earnings even if the second half has not occurred yet. Simply multiply the first half of the earnings to project through the year.
  2. Do you use past profits or projected future earnings? Most appraisers recommend using the profits from the last three years to establish more credibility in the sale; however, you can weight the more recent years more heavily, if the profits are increasing each year, to suggest projected income.
  3. Are the current earnings an anomaly or are they consistent? Many owners will sell after a spike in profits, but you should evaluate the business risk by looking at a more thorough review of a business’s earning history.
  4. What’s the business’s climate? How established is the business? Can it run without the current staff or leadership team? Are there competitors moving in that have yet to affect the company’s earnings? Is the economy growing or shrinking? What is the impact of new technologies on the industry?

(Are you in the process of selling your company? The first thing to do is to identify “destroyers” that can impact your company’s value. Click here to download your free “Top 10 Destroyers of Value“.)

There are many factors to consider when evaluating a company, and many aspects to include when determining the “true” value. Looking at the profits solely will not give you the full picture of a company’s worth.

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Adjusted EBITDA

See Also:
EBITDA Valuation
Calculate EBITDA
Valuation Methods
EBITDA Definition
Multiple of Earnings

Adjusted EBITDA

Adjusted EBITDA is a valuable tool used to analyze businesses for the purposes of valuation and potential acquisition. It is also called Normalized EBITDA as it systematizes cash flow and deducts irregularities and deviations. Adjusted EBITDA is an additive measure used to determine how much cash a company may produce annually and is typically used by security analysts and investors when evaluating a business’s overall income; however, it is important to note business valuation using Adjusted EBITDA is not a Generally Accepted Accounting Principles standard and should not be used out of context as various companies may categorize income and expense divisions differently.

EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization and is a meaningful measure of operating performance as it allows businesses and investors to more fully evaluate productivity, efficiency, and return on capital, without factoring in the impact of interest rates, asset base, tax expenses, and other operating costs.

Adjusted EBITDA is a useful way to compare companies across and within an industry. Many consider it a more accurate reflection of the company’s worth as it adjusts for and negates one-time costs such as lawsuits, start-up or development expenses, or professional fees that are not recurring, just to name a few. More importantly, adjusting EBITDA often reflects in a higher sale’s price for the owner.

Adjusted EBITDA Margin Calculation

Adjusting EBITDA measures the operating cash flow using information acquired from income statements. It can be measured annually but is most beneficial when averaged over a three to five year period in order to account and adjust for any anomalies. Generally speaking, a higher normalized EBITDA margin is preferred, and the larger a company’s gross revenue, the more valuable this new measurement will be in a future acquistition.

(Are you in the process of selling your company? The first thing to do is to identify “destroyers” that can impact your company’s value. Click here to download your free “Top 10 Destroyers of Value“.)

Typically, analysts will then normalize or adjust the standard EBITDA by considering other expenses outside the operating budget. Adjusted EBITDA is found by calculating the Net Income, minus Total Other Income (Expense), plus Income Taxes, Depreciation and Amortization, and non-cash charges for stock compensation.

At this point, you are probably curious how to calculate Adjusted EBITDA. The following is a simplified example of how you might begin calculating this formula for your business. Start with EBITDA; then add back value to your company by considering areas of excess and factoring in one-time costs.

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Differences between EBITDA versus Adjusted EBITDA

There are a few key differences between EBITDA and Adjusted EBITDA. EBITDA, or Earnings Before Interest, Taxes, Depreciation and Amortization, idenitifies a company’s financial profits by calculating the Revenue minus Expenses (excluding interest, tax, depreciation and amortization). It compares profitability while excluding the impact of many financial and accounting decisions. The EBITDA margin is an assessment of a company’s operating profitability as a percentage of its total revenue. Calculating the EBITDA margin allows analysts and investors to compare companies of different sizes in different industries because it formulates operating profit as a percentage of revenue.

Adjusted EBITDA, on the other hand, indicates “top line” earnings before deducting interest, tax, depreciation and amortization. It normalizes income, standardizes cash flow, and eliminates abnormalities often making it easier to compare multiple businesses. Redundant assets, owner’s salaries or bonuses, and a facility rental above or below fair market value are all examples of adjustments that would need to be accounted for when evaluating the value of a company for a buyer.

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Valuation Methods

See Also:
Financial Ratios
Required Rate of Return
Internal Rate of Return Method
EBITDA Valuation
What is a Term Sheet?
Adjusted EBITDA
Multiple of Earnings
Business Valuation Purposes

Valuation Methods

There are a variety of approaches to valuing a firm and its equity. The two most popular approaches are discounted cash flow (DCF) methods and market earnings multiple based methods.

Discounted cash flow methods generally project future expected cash flows, discount the value of each of those flows to present value using a discounted rate, and then take the sum of those discounted values to represent the total value of the firm or the total value of the equity. This Free cash flow to the firm (FCFF) method arrives at a total firm value. Free cash flow to equity (FCFE) values the total equity in a firm.

Market earnings multiple methods typically project out a future adjusted earnings amount for the next twelve months. This earning amount typically uses EBITDA (earnings before interest, taxes, depreciation, and amortization) or net income and then multiplies that earnings estimate by a multiple which is within the range of what other similiar firms have sold for in recent transactions.

Valuation Methods Synopsis

As one might expect, valuations can often become complex. The subject of the proper discount rate has spawned numerous books itself. Valuation can also bring up contentious issues, particularly when the ownership interest represents a controlling stake or there is a less than liquid market for that interest.

When a valuation becomes complex, it is standard practice to consult with a valuation firm. Need help finding one? We will get you connected with one of our strategic partners for your valuation needs. Fill out the form below to get connected:

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EBITDA Valuation

See Also:
Valuation Methods
Success Is Your Business
Self-Liquidating Loans
What is dilution, how is it calculated, and how should you manage it?
Which Bank to Choose?
Calculate EBITDA
Adjusted EBITDA

EBITDA Valuation Method

There are multitudes of ways to value a company, as well as specific equity and debt claims on a company’s assets. One is the EBITDA valuation method, which relies on a multiple of EBITDA to arrive at a company’s enterprise value.

The definition of enterprise value is the total value of a firm’s equity and debt. It can be thought of as the total market value of a company’s expected cash flow stream. A company’s EBITDA is a measure of that stream. EBITDA is a company’s net income with tax, interest, depreciation, and amortization expenses added back. It is not an exact measure of a company’s cash flow, but it is one which has gained wide acceptance in the banking and investment communities.

The enterprise valuation formula is expressed as:

Enterprise Value = Multiple * EBITDA

where EBITDA is typically projected for the next twelve months. Sometimes, the amount used is the actual EBITDA of the company over the last twelve months and is labelled as “LTM EBITDA.”

EBITDA Valuation Multiple

The multiple is usually based on comparable actual sales transactions which have occurred recently in the company’s industry, though often the derived multiples of publicly traded companies in the industry are used in addition to or in lieu of actual transactions.

Also, while a single value for the EBITDA multiple may be used, often a range is given, based on the distribution of comparable multiples, with abnormally high or low multiples excluded so as to provide a useful range for the end user of the valuation.

Valuing Equity Using the EBITDA Valuation Method

The EBITDA valuation method can be used to value a company’s total equity. After arriving at the company’s enterprise value using the formula described above, the net debt of a company is subtracted to determine the value of the equity claim on the firm’s total cash flow (methods used to directly value equity adjust the firm’s cash flow to yield the cash flow available to shareholders, which is also known as “Free Cash Flow to Equity.”

The formula to value equity using the EBITDA valuation method is:

Equity Value = Enterprise Value – Total Debt – Cash and Cash Equivalents

 

Problems with the EBITDA Valuation Method to Value Equity

The primary problem is that this method relies on EBITDA as a measure of a firm’s cash flow, ignoring other significant factors which can impact a company’s cash flow, such as changes in working capital and capital expenditures.

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