As a law firm, we don’t carry out valuations of businesses. We as solicitors, however, are often involved in business valuation discussions. A friend at an accountant firm explained to us the approaches taken to value privately held businesses. There are three main approaches: earning multiples, cashflow analysis and asset based.
Earning multiples
This is the usual method. The overall profit for the owner is calculated from the latest accounts and then a multiple based on the company’s business category is applied to it. Small service related businesses generally have a multiple of 2 to 2.5 times, whilst small manufacturing businesses generally receive multiples of 3 to 3.5 times.
Cashflow analysis
Using a cash flow analysis, expected revenues and costs for usually five years are forecasted to arrive at expected annual overall profits for the owner. Then all future expected annual overall profits for the owner (into perpetuity) are estimated. A discount rate is then applied to each annual overall profits for the owner, which reflects the time value of money and riskiness of the business. The value of the business being the sum of all the annual overall profits with the relevant discount rate applied.
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Asset based
Under the asset-based method, the individual assets of the business (eg property, equipment, stock and intangibles) are valued, with the sum being the value of the business.
Although our lawyers are experts in company and commercial law, for valuations we would refer you on to our accountant colleagues.