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Other Methods of Valuing a Business
Value of Specific Intangible Assets
This is an often-overlooked approach to valuation. Yet in some cases it is the only appropriate approach that will result in a sale. The approach is based upon the buyer's buying a wanted intangible asset versus creating it. Many times buying can be a cost efficient and time saving alternative.
For example, I sold a temporary employment agency. This agency specialized in placing health care assistants (such as nurses aids) in hospitals and nursing homes. Because there is a shortage of these workers in the area where the selling company did business, placing workers was not difficult. However, finding qualified workers was very difficult.
I approached firms in the same or related businesses. Through my research, I calculated that recruiting a qualified worker cost at least $700 for an agency. Therefore, we asked a price of $600.00 for each worker in the pool of available employees.
To the buyer, this not only saved $100.00 per worker, but it also cut down on the time it would take to recruit. The overhead of the selling company was not an issue because the buying company already had the system in place that the overhead expense was paying for (offices, computer system, phones, etc.). In fact, whether the seller was making or losing money was of little consequence to the buyer. The value to the buyer was the value of buying a qualified worker versus recruiting a worker through the more traditional method of advertising, interviewing, etc.
In another case, we were retained by a large (greater than 10,000 employees) firm that wanted us to find potential acquisition targets. The president of the subsidiary of the company told us that he was less concerned with the financials of the company that we were presenting than with the personality of the owner. "I'm more interested in acquiring proven entrepreneurial talent than in acquiring a piece of software," he said.
A common application of this method is the acquisition of a customer base. Customers with a high likelihood of being retained are valuable in most industries. Examples of industries where companies are bought and sold based upon the value of the customer base include insurance agencies, advertising agencies, payroll services, and bookkeeping services.
In practice the buyer will often ask for a credit for each customer that is not retained for a stated period of time. For example, a firm may offer $100 per customer, with a pro-rated credit for each customer that leaves during the twelve months following the closing of the sale. Pro-rating is based upon when the customer leaves-- if the customer leaves after 6 months, for example, half of the $100 would be returned to the seller.
The value of a customer base approach is often used to value companies when the acquirer will have a far different cost structure than the seller. For example, if a large payroll processor or web hosting company acquires a small one, their costs for software, hardware, and labor will not match those of the acquired company. The customers will be moved over to the acquiring company's software and hardware and will be supported by the acquiring company's existing personnel. Even if the selling company's employees are retained, their duties and pay will likely change and their salaries will be spread over a larger company base.
Comparisons to Public Companies
Small businesses typically sell for a multiple of less than 5 times EBITDA, whereas publicly traded companies sell for P/E ratios of 20. I have seen some business brokers start with public company multiples and discount for greater risk, less liquidity, and so on to try to arrive at a value for a small company. Unless your company is large enough that it may be able to do an IPO in the next 3-5 years then this method is unlikely to yield meaningful results.
Conclusion
There is no surefire way to value a company for buying and selling purposes. The true value is the perceived value to a buyer who is ready, willing, and able to buy it. However, there are a number of approaches to estimate value; some of those are discussed above. It is not unusual for a buyer to ask for the logic behind an asking price. Having a good answer to that question will enhance your chances of selling your firm for the desired price.
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