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A business is defined as "an organized method of routinely producing revenues over
a period of time". 'Fair Market Value', as defined by the Internal Revenue Service
in Revenue Ruling 59-60, is "the price at which property would change hands between
a willing buyer and a willing seller when the former is not under compulsion to
buy and the latter is not under compulsion to sell; both parties having reasonable
knowledge of relevant facts".
The worth of a business is normally divided into two major categories:
- The Asset Value - machinery, equipment, building, land, usable stock and other legal
rights.
- The Goodwill Value - the premium over asset value that a buyer will pay for a business,
i.e., historically recorded cash flows and projected future earnings.
There are several factors that may play a part in determining a business’ value
including:
- Market value of assets
- Value of rights, privileges and knowledge
- Historic trends, along with future projections of revenues, expenses and cash flows
- Perception of risk associated with the quality and continuity of earnings
- Type or class of buyer interested and their perception of the opportunity
- Aesthetic appeal
The techniques and formulas that are used in arriving at values are those that are
most often accepted by business buyers and their professional advisors. And, the
results normally assume that the buyer and seller are considering alternative investments
so that a transaction occurs when the economic incentive to purchase is equal to
the economic incentive to sell.
Generally, there is no economic incentive to invest monies in a business, which
is not capable of producing a income in excess of both an operator’s salary, and
a reasonable return on invested capital.
While the application of financial formulas is often fairly straightforward, it should
be recognized that the marketplace is made up of many types of buyers. And a buyer
can may be either very generous or very conservative, or somewhere in between, depending
upon his perception of applicable criteria. Allowing for these differences is not
always easy since the feelings, desires and judgments of both the seller and potential
buyer must be taken into account.
A solid r valuation will normally develop a range of values that indicates how the
marketplace of different buyers and investors might be likely to view the business.
This range often will suggest the highest price a seller might expect and the lowest
price a seller should accept.
Value
It should be understood that most often, the values do not presume that the buyer
is assuming any of the company's debts, liabilities and obligations that exist
at the time of a sale. Those items are normally the responsibility of the current
owners unless addressed as a part of the acquisition process. Likewise, the value
of certain assets, such as company vehicles, cash and accounts receivable must also
be addressed in the acquisition to determine whether they go with the business or
stay with the former owner.
Methods and Techniques
There are several methods normally used to value a business. Among them: are:
- Capitalization of Profits
- Rothschild Banking Formula
- Multiples of Revenue
- Rules of Thumb
- Comparison with Public Company Transactions
These approaches, or a combination of them, are selected in particular valuations
due to specific items such as the history, size, and profile of the Company, and
the segments of the marketplace that might participate in its purchase. These approaches
acknowledge asset value, and normally focus upon other important factors such as
the company’s adjusted cash flows, excess earnings, return on investment and its
capacity to carry debt.
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