Business Valuation

Business Valuation

Business Valuation is the process of determining the “Economic Worth” of a Company based on its Business Model and external environment and supported with reasons and empirical evidence. In business valuation, variety of business valuation methods typically categorized into three core Valuation approaches are considered and Premium & Discounts applied based on standard & premise of valuation to arrive at the Business Valuation for different purposes.

Generally acceptable methodologies of valuation

There are broadly three approaches to valuation which need to be considered in any business valuation exercise. A number of business valuation models can thus be constructed that utilize various methods under the broad business valuation approaches. Most treatises and court decisions encourage the valuer to consider more than one method, which must be reconciled with each other to arrive at a value conclusion. Understanding of the internal resources and intellectual capital of the business being valued is as important as the economic, industrial and social environment.

Asset approach (NAV): Generally the Net Asset Value reflected in books do not usually include intangible assets enjoyed by the business and are also impacted by accounting policies which may be discretionary at times. NAV is not perceived as a true indicator of the fair business value. However, it is used to evaluate the entry barrier that exists in a business and is considered viable for companies having reached the mature or declining growth cycle and also for property and investment companies having strong asset base.
o Book value method: It is based on the balance sheet review of assets and liabilities;
o Replacement cost method – It is based on current set up cost of plant of a similar age, size and capacity;
o Liquidation value method – It is based on estimated realizable value of various assets.

o Discounted Cash Flow Method (DCF) – DCF expresses the present value of the business as a function of its future cash earnings capacity. In this method, the appraiser estimates the cash flows of any business after all operating expenses, taxes, and necessary investments in working capital and capital expenditure is being met. Valuing equity using the free cash flow to stockholders requires estimating only free cash flow to equity holders, after debt holders have been paid off.

o Capitalization of earning method – The capitalization method basically divides the business expected earnings by the so-called capitalization rate. The idea is that the business value is defined by the business earnings and the capitalization rate is used to relate the two.

o Market based approach – In this method, value is determined by comparing the subject, company or assets with its peers or Transactions happening in the same industry and preferably of the same size and region. This is also known as relative valuation method.

o Comparable companies multiples method– Market multiples of comparable listed companies are computed and applied to the company being valued to arrive at a multiple based valuation.

o Comparable transaction multiples method – This technique is mostly used for valuing a company for M&A, the transaction that have taken place in the industry which are similar to the transaction under consideration are taken into account.

o Market value method – The Market value method is generally the most preferred method in case of frequently traded Shares of companies listed on stock exchanges having nationwide trading as it is perceived that the market value takes into account the inherent potential of the company.

Other valuations methods:

Contingent claim method – Under this valuation method, option pricing model is applied to estimate the Value. Generally ESOP valuation for accounting purpose is done using the black scholes method. Now even Patent Valuation is also done using black scholes method.

Price of recent investment method – Under this valuation method, the recent investment in the business by an independent party may be taken as the base value for the current appraisal, if no substantial changes have taken place since the date of such last investment. Generally the last investment is seen over a period of last 1 year and suitable adjustments are made to arrive at current value.

Venture Capitalist method – Venture Capitalist Method is majorly used by venture capitalist looking for making investments in start-up companies.

First Chicago Method – First Chicago approach takes into consideration three scenarios: Success, Failure and Survival case and associate probability to each case to find the weighted average price of a start-up business.

Adjusted discounted cash flow method – This method is the scientific tool to judge the value of a start-up on the basis of its potential which is translated in the form of cash flow and adjusted with differential discount rates based upon the risk perception of a start-up entity.