Fall 2014 issue of Horizons

A common mistake that business owners often make is not fully understanding the value of their company. Business owners tend to rely on anecdotal information, such as what their neighbor sold his business for or what a competitor was sold for recently, to determine the value of their business. Sometimes, business owners don’t even engage in that limited level of “research” and, instead, allow the amount that they need to sell their business for to bias their opinion of what their company is actually worth. A poor understanding of the valuation of a business can lead to disappointment at the exit or even the late realization that an exit is not even possible given the inability to fund one’s retirement with the lower than expected proceeds from an exit. These are all reasons why it’s critically important to regularly value your business. In fact, it is strongly recommended that you consider having an independent valuation performed on your business prior to marketing your business for sale. It is an unfortunate situation when business owners enter the sale process, incur significant attorney and investment banker fees, and then discover that the value they thought the business had (and what they had been told by the investment banker) was nowhere close to what the market was willing to offer.

At that point, the business owner has two choices:

∙ Sell for significantly less than he thought entering the process OR ∙ Continue to run the business and lose any potential benefit from the sunk attorney and investment banker costs

Neither choice is desired and could be avoided by having an independent valuation performed prior to entering the sale process.

While RubinBrown can’t provide a set of hard and fast rules that you can use to value your business, this information is an overview of the methodologies most commonly used in practice. If you decide to have an independent valuation performed, this information will help you more fully understand the process. You can also benefit from exploring these common methodologies if you make the decision to forgo a valuation.

The three primary approaches to valuing a business are described in the following pages.

Income Approach The income approach determines the value of a business by capitalizing its future cash flows.

The basic premise of this approach is that the price a willing buyer would pay is based on the economic benefits of ownership that are available to the buyer, namely, the cash flows which the business generates.

The cash flows in this context are defined as net operating income after tax, plus depreciation, less capital expenditures and working capital needs. These are the cash flows available to all

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