Whether you are buying or selling a global corporation, an operating division, a local restaurant, or a share of stock, the question, "What is its value?" outweighs most others, and for good reason. The rate of return from a good company or a good stock is likely to be disappointing if purchased at too high of a price. Likewise, underestimating the value of an entity in a sales transaction can leave plenty of the owners' money on the table.
Valuing an ongoing business - large or small - is neither easy nor exact. The field of finance, however, has developed methods for getting close to the value. This post will introduce you to several methods.
But before we get started, consider several cautions. The true value of a business is never knowable with certainty. We may seek it, but we can never be sure that we have found the true value of the business. This lack of certainty is the result of two problems.
1. Alternative valuation methods consistently fail to produce the same outcome, even when meticulously calculated.
2. The product of valuation methods is only as good as the data and the estimates we bring to them, and these are often incomplete or unreliable. For example, one method depends heavily on estimates of future cash flows. In the very best cases, those estimates will only be close. In the worst cases, they will be far from the mark.
Another consideration is that a company is worth different amounts to different parties. Different prospective buyers are likely to assign different values to the same set of assets.
The acquisition of a small, high-tech company, for example, might provide an acquirer with the technology it needs to leverage its other operations. This explains, in part, why so many firms are bought out for more than the market value of their existing share.
It is also important to keep in mind that valuation is the province of specialists. Small and closely held businesses typically turn to professional appraisers when their value must be established for purpose of the entity's sale, to determine the value of its shares when an employee stock ownership trust is used, or for some other purpose. When large, public firms or their business units are the subject of a valuation, executives generally turn to a variety of full-service accounting, investment banking, or consulting firms. Many of these vendors have departments devoted entirely to mergers and acquisitions, in which valuation issues are a central focus. Nevertheless, a well-rounded manager should understand the nature of different valuation methods - and their strengths and weaknesses.
Valuation problems often arise in the context of closely held businesses - that is, businesses with only a few owners - or in the sale of an operating unit of a public company. In neither case are there publicly traded ownership shares. Public markets for ownership, such as NASDAQ or the New York Stock Exchange, make value more transparent. Everyday buying and selling in these markets establishes a company's per-share price. And that price, multiplied by the number of outstanding shares, often provides a basis for a fair approximation of company value at a point in time.
Valuing an ongoing business - large or small - is neither easy nor exact. The field of finance, however, has developed methods for getting close to the value. This post will introduce you to several methods.
But before we get started, consider several cautions. The true value of a business is never knowable with certainty. We may seek it, but we can never be sure that we have found the true value of the business. This lack of certainty is the result of two problems.
1. Alternative valuation methods consistently fail to produce the same outcome, even when meticulously calculated.
2. The product of valuation methods is only as good as the data and the estimates we bring to them, and these are often incomplete or unreliable. For example, one method depends heavily on estimates of future cash flows. In the very best cases, those estimates will only be close. In the worst cases, they will be far from the mark.
Another consideration is that a company is worth different amounts to different parties. Different prospective buyers are likely to assign different values to the same set of assets.
The acquisition of a small, high-tech company, for example, might provide an acquirer with the technology it needs to leverage its other operations. This explains, in part, why so many firms are bought out for more than the market value of their existing share.
It is also important to keep in mind that valuation is the province of specialists. Small and closely held businesses typically turn to professional appraisers when their value must be established for purpose of the entity's sale, to determine the value of its shares when an employee stock ownership trust is used, or for some other purpose. When large, public firms or their business units are the subject of a valuation, executives generally turn to a variety of full-service accounting, investment banking, or consulting firms. Many of these vendors have departments devoted entirely to mergers and acquisitions, in which valuation issues are a central focus. Nevertheless, a well-rounded manager should understand the nature of different valuation methods - and their strengths and weaknesses.
Valuation problems often arise in the context of closely held businesses - that is, businesses with only a few owners - or in the sale of an operating unit of a public company. In neither case are there publicly traded ownership shares. Public markets for ownership, such as NASDAQ or the New York Stock Exchange, make value more transparent. Everyday buying and selling in these markets establishes a company's per-share price. And that price, multiplied by the number of outstanding shares, often provides a basis for a fair approximation of company value at a point in time.
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