Business Valuation

Valuing a business is not easy.  It requires a great deal of research, calculations, and interpretation.  Several shortcut methods such as the multiplication of current earnings or revenues by an arbitrary factor or the stipulation of values for buyout agreements can be used under special circumstances to quantify a preliminary valuation.  However, these methods should never be interpreted as quantifications of fair market value.

The generally accepted definition of Fair Market Value is the cash or cash-equivalent price at which an asset would change hands between a willing buyer and a willing seller, both having the means to complete the transaction, and neither acting under duress.  Furthermore, Fair Market value does not refer to a specific seller and a specific buyer, but merely to hypothetical parties to arms-length transactions in general.

In valuing a business, regardless of the size or type of company, or which valuation method is used, the business valuation process itself remains relatively constant.  It comprises four major steps:

• Forecasting the company’s cash flow for a specified number of years

• Estimating the cost of capital to be included in the valuation analysis

• Determining the continuing value of a business beyond the valuation date

• Analyzing and interpreting the results of calculations and assumptions

With these points in mind and in valuing businesses, INAVISIS® uses multiple valuation methodologies based on the type of business and depending on the purpose of the valuation.  One method that is readily accepted as a standard valuation method is the Excess Earnings Method (EEM).  The EEM was originally defined by Internal Revenue Service Revenue Ruling 59 – 60 and later modified by Revenue Ruling 68 – 609.  Here is a summary of the steps the Ruling calls for, and that INAVISIS® uses in our valuation:

1. Determine the value for all net tangible assets (excluding intangibles).

2. Establish a “normalized” earnings level.

3. Estimate an appropriate capitalization rate applicable to that portion of the expected return based on or supported by net tangible assets.

4. Multiply the net tangible asset value by that rate to determine the amount of value generated by net tangible assets.

5. Subtract the amount in step 4 from the “normalized” earnings in step 2.  The result is defined as “excess earnings.” Theoretically, this is the amount of earnings above a fair return on net tangible assets that could be expected.

6. Establish an appropriate capitalization rate to apply to the sum of excess earnings and earnings from intangible assets - patents, leases, copyrights, etc.

7. Add this value to that derived in step 1 to arrive at a total business valuation.

 

To learn more about INAVISIS’ Business Valuation program, contact Shehadeh Khoury at 858-794-1555 ext 205 or shkhoury@inavisis.com