Sidebar: The Do-It-Yourself Appraisal
So what are you worth? There's no precise answer, of course. The specific number is less important to you than the general range and the process that gets you there.
If you need a valuation and are asking the question for the first time, many businesses opt for letting an outside appraiser figure out the answer. These reports, which run up to 50 pages, provide the owners with a blueprint that can be tracked afterward. But like most other tasks, it's also possible to do this yourself. Ballpark valuation can be derived from at least six widely used techniques, each involving varying degrees of difficulty and yielding different levels of precision. And, with the information on pages 78 to 79, your P&Ls, and the 10 different industry metrics listed can also give you a good estimate, although it can't tell you whether your business deserves more or less than the typical company in your field.
Book Value: The old classic, with an emphasis on old. The methodology is simple: Take your assets, including cash, physical plant, and receivables, and subtract liabilities and debt. It's a great formula -- if you're a bank or insurance company. But it's pretty poor for everybody else except as a reality check. Adjusted book value, which factors in non-balance sheet items like intellectual property, goodwill, and depreciated assets, works better but still suffers by its simple adherence to asset-based value. "I don't know anyone who's ever done a deal where book values are the way to go," says David Newton, a professor of entrepreneurial finance at Westmont College in Santa Barbara, Calif., who frequently testifies about valuations as an expert witness in litigation, "but I do use it when I get a value in another model and it's way out of line." Perhaps the best thing about a book value appraisal is that it's so simple. Such asset-based appraisal will almost always prove too low, but it gives you a floor to start from.
Liquidation Value: Not as dated as book value but close. The premise is simple: If you had to raise as big a pile of cash today as you could, what could you get for the pieces of your company? Good receivables might fetch 80¢ on the dollar, short-term inventory maybe 60¢. It's basically a snapshot of the fair market value of what you currently hold. A better but still flawed version of this model: replacement cost, as in what would it cost me to get everything I have if I started from scratch. Like book value, the liquidation/replacement models derive from the largely outdated concept that a business is only as good as its hard assets.
Excess Earnings: Think of this technique as a book value concept for the 21st century. It starts with your tangible assets, and then takes the next step by asking what would be a standard return on equity. Any money earned above this amount is considered excess earnings -- an income stream that clearly has value above the core value. Capitalize this stream, add it to the original book value, and you have your figure. Not a bad exercise, but problems exist both because of the way book value itself is calculated and the inexact science of figuring out a proper return-on-equity benchmark. Newton gives an example: A consulting firm that leases all its equipment might have just $200,000 in assets on its books but earn $10 million a year, which would give it a return on equity of 5,000% and an excess earnings valuation that is off the charts.
Multiples Models: The favorite of back-of-the-envelope valuators everywhere. Take your earnings or sales, and multiply it by the P/E or P/S multiples of comparable public companies. Better yet, use our table, or similar special industry information for private companies, to get a more accurate valuation multiple. Volatility is the problem here: Are your most recent profits and sales reflective of your long-term prospects -- and ditto for your comparables? For a smaller private company, both profits and sales can prove erratic and often fail to recognize debt and other intangibles properly. The comparable multiples of public companies, meanwhile, might be inflated or deflated by company-specific occurrences such as a new product rollout or management turnover. That said, if the earnings or sales figures are stable, it's a pretty solid technique, albeit one that fails to indicate specific areas to improve upon.
Comparative Value: Every homeowner knows this concept -- a real estate broker demonstrates what similar houses in similar neighborhoods have sold for recently to demonstrate market value. Substitute a business broker, and the same method can work for private companies. Unlike title transfers, which are almost always publicly available, company transaction information is harder to gather. Still, it's out there and if, like the multiples models, the comparable companies are carefully screened, it's a solid barometer.
Discounted Cash Flow: This is a Wall Street favorite, the basis for how many analysts come up with their target ranges. Despite that currently dubious affiliation, it's probably the most respected valuation technique. It takes the excess earnings concept and reverses it, so that imperfect yardsticks like book value and standard return on equity are removed. The premise here: Rather than assets, a company's value is based on its ability to generate sustainable long-term cash flows. Past performance is less important than a thorough analysis of margins, overhead, debt, tax bracket, long-term obligations, labor and material costs, and sales growth. Using a forecast of future cash flow, you can treat it like an annuity and discount it to present value. R.L.
