Business Valuation Methods

Adapted from content excerpted from the American Express® OPEN Small Business Network

There are a number of instances when you may need to determine the market value of a business. Certainly, buying and selling a business is the most common reason. Estate planning, reorganization, or verification of your worth for lenders or investors are other reasons.

Valuing a company is hardly a precise science and can vary depending on the type of business and the reason for coming up with a valuation. There are a wide range of factors that go into the process -- from the book value to a host of tangible and intangible elements. In general, the value of the business will rely on an analysis of the company's cash flow. In other words, its ability to generate consistent profits will ultimately determine its worth in the marketplace.

Business valuation should be considered a starting point for buyers and sellers. It's rare that buyers and sellers come up with a similar figure, if, for no other reason, than the seller is looking for a higher price. Your goal should be to determine a ballpark figure from which the buyer and the seller can negotiate a price that they can both live with. Look carefully at the numbers, but keep in mind this caution from Bryan Goetz, president of Capital Advisors, Inc., a business appraiser: "Businesses are as unique and complex as the people who run them and are not capable of being valued by a simplistic rule of thumb."
Here are some of the common methods used to come up with a value.

* Asset valuation
* Capitalization of income valuation
* Owner benefit valuation
* Multiplier or market valuation

Asset Valuation

Asset valuation is used when a company is asset-intensive. Retail businesses and manufacturing companies fall into this category. This process takes into account the following figures, the sum of which determines the market value:

* Fair market value of fixed assets and equipment (FMV/FA) - This is the price you would pay on the open market to purchase the assets or equipment.
* Leasehold improvements (LI) - These are the changes to the physical property that would be considered part of the property if you were to sell it or not renew a lease.
* Owner benefit (OB) - This is the seller's discretionary cash for one year; you can get this from the adjusted income statement.
* Inventory (I) - Wholesale value of inventory, including raw materials, work-in-progress, and finished goods or products.

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Capitalization of income valuation

This method places no value on fixed assets such as equipment, and takes into account a greater number of intangibles. This valuation method is best used for non-asset intensive businesses like service companies.

In his book "The Complete Guide to Buying a Business" (Amacom, 1994), Richard Snowden cites a dozen areas that should be considered when using Capitalization of Income Valuation. He recommends giving each factor a rating of 0-5, with 5 being the most positive score. The average of these factors will be the "capitalization rate" which is multiplied by the buyer's discretionary cash to determine the market value of the business. The factors are:

* Owner's reason for selling
* Length of time the company has been in business
* Length of time current owner has owned the business
* Degree of risk
* Profitability
* Location
* Growth history
* Competition
* Entry barriers
* Future potential for the industry
* Customer base
* Technology

Again, add up the total ratings, and divide by 12 to come up with an average value to use as the capitalization rate. You next have to come up with a figure for "buyer's discretionary cash" which is 75% of owner benefit (seller's discretionary cash for one year as stated on the income statement). You multiply the two figures to determine the market value.

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Owner benefit valuation

This formula focuses on the seller's discretionary cash flow and is used most often for valuing businesses whose value comes from their ability to generate cash flow and profit. It uses a fairly simple formula -- you multiply the owner benefit times 2.2727 to get the market value. The multiplier takes into account standard figures such as a 10% return on investment, a living wage equal to 30% of owner benefit, and debt service of 25%.

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Multiplier or market valuation

This approach finds the value of a business by using an "industry average" sales figure as a multiplier. This industry average number is based on what comparable businesses have sold for recently. As a result, an industry-specific formula is devised, usually based on a multiple of gross sales. This is where some people have trouble with these formulas, because they often don't focus on bottom line profits or cash flow. Plus, they don't take into account how different two businesses in the same industry can be.

Here are a few industry multiplier examples, as mentioned in "The Complete Guide to Buying a Business" by Richard Snowden (Amacom, 1994):

* Travel agencies - .05 to .1 X annual gross sales
* Ad agencies - .75 X annual gross sales
* Retail businesses - .75 to 1.5 X annual net profit + inventory + equipment

To find the right multiplier for your industry, you can try contacting your trade association. Another option is to utilize the services of a broker or appraiser who specializes in businesses such as yours.

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Creating an Effective Job Description

Adapted from content excerpted from the American Express® OPEN Small Business Network

Creating a clear job description before you begin the hiring process can help you choose the best candidate from a pool of applicants. It usually consists of two areas -- a summary of the job's responsibilities, and a list of the key duties that will be performed. It's worth your time and effort to think the job description through completely. A confusing, hazy, or incorrect description can make it much harder for you to match a candidate and a job, because you're not sure about exactly what the job entails.

An accurate job description is also essential for drafting classified ads, job postings or other recruitment efforts. It lets you be clear on exactly which talents you're looking for, and focus your ad on those attributes to attract the most qualified candidates.

Use the tips below when you're drafting a job description.

Avoid generalizations

Be as specific as possible when you describe the duties and responsibilities you will need this employee to perform. Think in terms of the benefits this employee will provide to your organization or to your customers/clients. For example, don't describe a video store clerk simply as someone who will "rent videos to customers." Instead, if you use something like "will assist customers in choosing movies they will like by sharing his or her knowledge of recent or classic films," you will know you need someone who loves film and can convey their enthusiasm to your customers.

Prioritize

Once you've created a list of responsibilities and duties, put them in order of importance. Start with skills that are integral to the job to be performed. This way you will know what is necessary for the successful execution of the job, what simply is desired, and what may actually be irrelevant. Hiring is often a matter of trade-offs, so by prioritizing, you're helping yourself determine what you can or can't live with.

Use measurable criteria

Be explicit about the kind of performance you're looking for from someone, and whenever possible look for ways to quantify those criteria with numbers or dates. Otherwise, you may find that you've hired someone who can perform the necessary tasks, but falls short in productivity or throughput. For example, will an account manager be working with one, four or ten accounts at a time? Will a bookkeeper be expected to update accounts receivable daily, weekly or monthly?

Ask for help

Spend time with others in your organization who will be managing or interacting with a new employee to find out what they think the chief duties of this person should be. Those who are on the front lines with someone often know more about what day-to-day skills are necessary to perform a job successfully. You'll find this input invaluable

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