Business Valuation: Is It a Science or an Art?
Business valuation and business valuation methodology is a tricky topic, that is often misunderstood. The job of valuing a business or company isn’t so much a science as it is an art, since valuation calls for precise scrutiny from the part of the valuator. The processes of determination vary when it comes to assessing the value of a company. One valuator may place a different valuation for the same company as another with the same credentials, thus the end decision will vary due to the separate inputs.
This can even happen if the two valuators use the same approach.The crux of the matter faced by the valuator is determining the proper methodology that will be most appropriate to the company in question. Said valuator must take into consideration the purpose of the valuation, considering the nature of the business operations that set the valuation perspective, then appropriate business valuation methods to be put into practice.
Desired Goal of Valuation
Taking into consideration the specifications used for valuing a firm or public shares, most people concur that the important variable is the objective of the business valuation. The most agreed upon factors for valuing a business consist of the following:
a) Buying a business, merging a business, acquiring a business or a business line;
b) Selling a business, divesting a business line or business interest, forming a joint venture;
c) Setting up a buy / sell agreement for a partnership or a minority shareholder;
d) Breakup of a partnership or corporation;
e) Bankruptcy / reorganisation;
f) tax planning / estate planning;
g) Shareholder disputes resulting from an estate or divorce.
Type of operations employed by businesses
Another important consideration for determining the valuation methodology is the kind of business that is in question. A company in possession of large property assets, inventory, or machinery will want to have the market value of said goods factored into the equation when considering the entirety of the appraisal. A service company on the other hand, possessing less assets will not.
Legal firms, healthcare, consulting, investment advisory, and companies that work in the fields of insurance and real estate could also possess specific goodwill characteristics which should also be taken into consideration during the valuation process.
The inputs of value
Valuators who utilize similar methods and approaches of business valuation could also come to alternating values for the same firm. Specific mathematical formulas that are used for the valuation of a company can be the same, but the inputs call for a certain amount of decision making on the part of the valuator.
The income approach
The income approach calls for one to forecast the company's future financial performance, taking into consideration the sources of income when discounts could play a part. The sources of income are set based on events in the future. Examples include trends in the market, economic outlook, post acquisition synergies, and the effects of a change in management. Said valuator will quantify all of this and make a decision based on the inputs of forecasted cash flows. This turns into a complex process, even more so when considering for a start-up.
Information pertaining to the historical financial performance of a company
Valuations usually base historical financial performance as the starting point for projections. A startup doesn't possess much of a financial history for a valuator to judge valid or not the growth estimations provided by the owners. An IT startup could be in the process of amassing its customer base and not yet have generated a positive cash flow. The valuator should have an informed comprehension of the business in order to decide if the estimations are accurate.
Comparables in the market
Comparisons based on the market still call for precise judgment since even two competitors with similar performance are still going to differ in many ways. Companies in the same field of operation have different consumer targets, work in varying geographical locations and differ in operating cost. Finding a market player upon which to judge small private companies can also be cumbersome, as can be assessing their business history. In this situation, the valuator must be experienced in this industry or be very interrogative in order to make proper decisions as to the inputs of the valuation.
When all is said and done, the valuator should have a proper comprehension of the reasons for valuation and the specific characteristics of the firm/business and their market niche in order to come to a good valuation.