7 basic principles of business valuationJean-Claude Desnoyers
As a Chartered Business Valuator (CBV), I am called upon to perform several types of mandates. I work with different size of businesses that operate in several industries. I notice, however, that business valuation is a little-known area. As an expert, I believe it is important that my clients and future clients learn more about the service I offer them.
As a result, over the next few weeks, I would like to give you some information about business valuations. For example, my next publications will focus on the seven basic principles of business valuation. In concrete terms, you will learn more about what allows the CBVs to navigate in the analysis of information and to exercise their judgment.
1. Value is determined at a specific point in time. It is a function of facts know and expectations made only at that point in time.
The first principle will allow you to understand the importance of the valuation date in the business valuation process. Mainly, the importance of the valuation date and how it affects the determination of the value of a business.
2. Value principally varies directly with the ability of a business to generate prospective discretionary cash flow, except in unusual circumstances where net asset liquidation results in a higher value
What does the future of the business look like? Is the future promising? The second principle of business valuation suggests that historical results (prior to the valuation date) can be used as a guide to define the business’ future results under certain conditions.
3. While market rates of return are constantly in a state of flux, they provide important benchmark indicators at any given point in time, and over the long term influence rates of return sought by individual corporate acquirers.
In order to establish an appropriate rate of return, the Chartered Business Valuator must consider several factors, including the type of industry, economic conditions, financing costs, etc.
4. In theory, the higher the underlying net tangible asset value of a business, the higher should be the going concern value of that business.
The fourth fundamental principle of business valuation is the assessment of the relationship between the net tangible value of a business and its operational value.
5. Where the value of a business is based on its prospective discretionary cash flows, it may have two distinct components: commercial (or transferable) value and non-commercial (or value-to-owner) value.
A quick review on the second principle will allow us to learn more about commercial (or transferable) value and non-commercial (or value-to-owner) value.
6. In both a notional and open market valuation context, as a general rule the greater the liquidity of a business interest, defined in terms of the number of prospective purchasers, the greater the value of the business interest.
With the sixth fundamental principle of business valuation, you will learn more about the importance of liquidity in determining the value of the business.
7. Absent a shareholders’ or other ownership agreement, or legislation or adjudicated legislative intent that dictates otherwise, the value of a controlling interest in a business may have a greater value per share than does a minority interest in that same business when each is viewed in isolation.
The seventh and last principle of business valuation will allow you to better understand the value of the minority stake versus the value of a controlling interest in a business. Both types of participation will be described and you will be able to better understand the difference between the two and the impact it has on the value of these participations.
With the help of upcoming publications, I hope to help you better understand the field of business appraisal, but also to understand the value added of involving a CBV.
If you would like to have your business appraised for sale, planning an estate or acquiring a business, or other, contact me today. I would be happy to help you.