What's My Company Worth?

This is a simple question with a not-so-simple answer. My initial response to "What's my company worth?" is "To whom?" The answer will be different if the standard of value is fair market value versus strategic value versus another standard of value. The answer differs because the buyer is different in each case.

In the case of fair market value, it is the theoretical "willing buyer" that helps determine a company's worth. With strategic value, worth might be determined by a competitor who is willing to pay more because of potential synergies that could be realized by combining the two companies.

Business owners often ask, how can someone not involved in a business put a value on that business? While an outsider will never fully understand all the nuances of a business the way an owner does, valuation professionals have established a systematic way to determine the value of any business. Their solution includes three standard approaches: market, income and asset. Within each of these approaches are several methods that are used to arrive at a value for any type of business.

Market Approach. With the market approach, the person conducting the valuation (the valuator) arrives at an indication of value by comparing the company being valued to similar companies. This is accomplished by analyzing comparable publicly traded companies and comparable businesses that have recently been acquired.

Successful usage of this approach requires access to a universe of arm's-length transactions involving companies similar to the subject company. Information on sales of comparable companies can be difficult to obtain for parties not privy to the transactions. However, when such data is publicly available, the market approach is the most objective and understandable of the three approaches.

Income Approach. While the market approach looks at a company externally, the income approach looks internally, estimating the company's value based on its ability to generate income. This estimate can be calculated by projecting cash flows into the future and discounting them back to the present at a stipulated rate of return. This is also known as discounted cash flow or DCF.

The estimate can also be calculated by capitalizing a free cash flow base at an appropriate rate of return. The free cash flows used in this valuation methodology are defined as "cash available to debt and equity holders after investment." This approach assumes that the income derived from the business will, to a large extent, control its value.

Asset Approach. The third approach is a general way of determining a value indication of a business' assets and/or equity interest. It uses one or more methods based directly on the value of the assets of the business, less its liabilities. The approach is used when the income stream generated by the business does not adequately reflect the value of the company.

The asset approach is usually employed in the valuation of holding companies, not-for-profit organizations, Real Estate Investment Trusts, start-up companies without an operating history and distressed companies. It is rarely used when assessing the value of a viable operating entity.

Once all three valuation approaches have been considered, the valuator will choose the methods that most accurately reflect the value of the business. This decision is based on the quality of the data available and the valuator's experience.

The structured series of approaches outlined above ensures that all of the relevant facts will be considered when answering the question, "What's my company worth?"

— Precision Machined Products Association