Factors
To Consider in Valuing a Closely Held Business
By Timothy M. McNamara, Co-founder of New England Divorce Solutions
Many owners of closely held businesses assume they
have a pretty good idea of their businesses' value. Often an owner may decide his or her
company's value based simply on cash flow and profit margin. While determining the value
of a closely held business may appear to be a straightforward process, it is actually
quite complex, involving consideration of numerous factors. A valuator must understand
their impact and, more important, know how to combine them to derive a reasonable,
well-supported value. To give you an idea of the factors a valuator considers, here's a
brief overview.
Competition
Fundamental to a determination of a closely held
company's value, competition encompasses a number of categories, including the company's:
- Relative size compared with other businesses in its
industry
- Relative product or service quality
- Product or service differentiation from others in the
industry
- Market strengths
- Market size and share
- Competitiveness within its industry in terms of price and
reputation
- Copyright or patent protection of its products
Management Ability
Is management skilled and experienced enough to keep the
company at the top of its game for the foreseeable future? Several factors can indicate
management ability:
- Accounts receivable, inventory, fixed asset and total
asset turnover,
- Employee turnover
- Condition of the facilities
- Family involvement, if any
- Quality of books and records
- Sales as well as gross and operating profit
Financial Strength
Consideration of financial strength entails a number of
ratios, including a company's:
- Total debt to assets
- Long-term debt to equity
- Current and quick ratios
- Interest coverage
- Operating cycle
Profitability and Stability of
Earnings
Another important factor is the financial stability of
the company, as revealed by its profitability during its operating history, including:
- The number of years the company has been in business and
its sales and earnings trends
- The life cycle of the industry as a whole
- The returns on sales, assets and equity
Other Factors
As if this were not enough, the valuator also has to
consider the economic conditions in which the company is operating, including the broad
industry outlook and the impact of various Internal Revenue Service (IRS) rulings and
court cases that may affect the company's value. In addition, the valuator must analyze
restricted stock studies and the values of comparable companies to determine their
relationship to the company's value. Intangible factors such as goodwill value and
noncompete agreements can be significant as well.
Finally, the valuator needs to determine the discount or
capitalization rate of the company, specify what percentage of the company is being
valued, and take into account any marketability or minority interest discounts.
Putting It All Together
Perhaps the most difficult part of the entire process is
knowing how to combine all of these factors in a meaningful way to reach a value that will
withstand any challenges by potential buyers, the IRS, dissatisfied partners or others.
Only a valuator with professional training, experience and expertise will be able to
accomplish this.
We have experience in performing these types of
valuations and possess the skill and expertise you need. Please give us a call with any
questions or problems concerning valuation matters. We would be glad to help.
(Back to article list) |
