Company Valuation Methodologies – The EMCO/Hanover Group Blog

As we all know there are 4 basic methodologies in valuing companies. The primary ones are: Asset Value; Income Value; Market Comparisons and Industry Standards. Each is described below and are considered to be an outgrowth of Revenue Ruling 59-60. However, there is also an unwritten standard often used when all else fails which Emco/ hanover often employs.

Asset: This considers the business to be a collection of assets that have a marketable value to a third party in an asset sale. Asset valuations are typically used for businesses that are ceasing operation and for specific types of businesses such as holding companies and investment companies. Asset valuation methods include the book value method, the adjusted book value method, the economic balance sheet method, and the liquidation method.
Income: Under this method valuations are based on the premise that the current value of a small business is a function of the future value that an investor can expect to receive from purchasing all or part of the business. Income valuations are the most widely used type of valuation. They are generally used for valuing small businesses that are expected to continue operating for the foreseeable future. Income valuation methods include: the capitalization of earnings method, the discounted future income method, the discounted cash flow method, the economic income method, plus other formula methods. Caution has to be exercised here because its use is highly dependent upon the continuation of the level of historical earnings and projected economic trends which as we know can often change during a company’s business cycle.
Market Comparison: This is based upon current conditions amongst active business buyers, recent buy-sell transactions, and other fairly comparable business entities. Financial attributes of these comparable companies and the prices at which they have transferred can server as strong indicators of fair market value of the subject company. One of the best examples of this is the capitalization determinations of publicly-traded companies as expressed on the various publicly-traded market exchanges, like the NYSE or for smaller companies, the OTC Market (Over-the-Counter).
Industry Standards: Often times a particular industry, like the distribution and separately a service business, is valued based on a multiple of its annual revenues. However, caution has to be used here for many companies are a composure of multiple industries and thus it is not unusual to find an appraiser using more than one valuation methods in determining the value of a business enterprise.

If all fails in assigning one of the above Methods, EMCO/Hanover then uses an unwritten standard, given its credentials in mergers and acquisition which is also used by investment bankers. It is 3x – 5x times pre-tax cash flow [based on certain analysis of a Company’s financial statements] but adjusted for any extraordinary or non-direct business expenses, to determine an investment’s fair value. EMCO/Hanover believes that such a standard is reasonable for non-publicly-traded, non-technology, based businesses, excluding real estate which has its own capitalization procedures.

One should also be cognizant of the alternative of establishing a “Fair Value” which is not a quoted price on any Stock Exchange which is the best evidence of fair value – quoted prices in an active market. However, if the market for a financial instrument is not active, then an entity can establish fair value by using valuation technique/ guidelines, as defined and referenced above particularly under the three other primary methods plus originally set out under Revenue Ruling 59-60 along with that presented under the AICPA’s IAS 39 Financial Instruments: Recognition and Measurement. —– A valuation technique: (a) incorporates all factors that market participants would consider in setting a price and (b) is consistent with accepted economic methodologies for pricing financial instruments.