Valuation Approaches / Methods
There are three overall approaches that the business appraiser uses in estimating the value of the ownership interest:
- Income Approach
- Market-Based Approach
- Asset-Based Approach
Each of the appraoches includes various methods that the valuation analyst will decide are appropriate to use depending on the specific circumstances of the assignment..
This approach recognizes that the benefits an ownership interest is derived from the cash flow to be derived from ownership; normally in the form of dividends or distributions and, down the road, a potential sale of the ownership interest. This method includes applying an investment rate of return that a hypothetical buyer would require when purchasing the ownership interest. Projection earnings and cash flows may be discounted using the expected rate of return. If the business is mature and earnings and cash flows are stable and expected to grow at a specific rate over the long-term, historical cash flows, or earnings in some cases, may be "capitalized" to estimate the value of the ownership interest.
The Market-Based Approach uses multiples obtained from similar-size public companies in the same or similar industgry to extrapolate to certain financial parameters of the your company. Frequently, the appraiser may not be able to locate publicly-held companies that are of similar-size. An alternative is to obtain sales transaction data of businesses in the same industry and use multiples derived from those transactions to estimate the value of your business.
The Asset-Based Approach may or may not be relevant. This approach is usually used in situations involving holding companies, asset-intensive business that do not have a strong history of generating earnigns and cash flow, or situations where the underlying assets are worth more than would be obtained by you continuing to operate your business. The specific assets owned by the business are appraised and the company's balance sheet is adjusted to reflect the values of those specific assets.
The appraiser may apply all of these approaches and weight the value results obtained using his/her expertise and judgment.