When someone buys a company or an interest in a small business in Odessa, what is that person really buying? Management? Markets? Technological skills? Products? Although each of these factors may be involved in the investment decision, what is actually being bought is a stream of prospective economic income from the small Odessa business.
In the simplest sense, the theory surrounding the value of a small business in Odessa depends on the future benefits that will accrue to the owner. The value of a small business in Odessa, then, depends upon an estimate of the future benefits and the required rate of return at which those future benefits are discounted back to a present value as of the valuation date. However, getting two or more parties with different economic and business expectations to agree on projected future benefits and the risks associated with achieving those projections is, perhaps, the most difficult task to value a small business in Odessa. Therefore, business appraisers have developed various approaches that use historically-based data rather than projected data to arrive at a valuation.
Background
You may be thinking, this is great information, but you still haven’t told me how to value a small business in Odessa. That is because there is no “quick and dirty” way to value a small business accurately. Valuing a small business is a blend of academic and professional backgrounds: the securities profession and the real estate profession. The body of knowledge required to estimate the value of a business or business interest is more akin to that required by the securities profession than by the real estate profession. This fact is reflected by the vast publications available and the typical academic and professional backgrounds of those practicing in the field of business valuation.
Approaches & Methods
The National Association of Certified Valuators and Analysts (NACVA) recognize an “income approach,” a “market approach” (sales comparison approach), and an “asset-based approach (similar to real estate’s “cost” approach), as the three approaches to value a small business in Odessa. There are various “methods” under each approach, which is a specific way to implement a business valuation within one of the three broad approaches. For example, the discounted cash flow and the capitalization of cash flow may be considered methods within the broader category of the income approach, and the guideline public company method and the transaction merger and acquisition method would fall within the market approach. It is important to note that the three broad approaches are not independent of each other but are interrelated.
Income Approach
Within the income approach, the business appraisal profession recognizes the discounted future economic income method and the capitalization of future economic income method. The two methods within the income approach require different rates at which to discount or capitalize the income stream. The steps for this method are summarized below:
- Determine the estimated future earnings of the small business in Odessa for the discrete period;
- Determine an appropriate discount rate that incorporates an appropriate safe rate of return, adjusted to reflect the perceived level of risk for the small Odessa business being valued;
- Determine a terminal or residual value; and
- Determine the present value of the estimated future earnings and terminal value as of the appraisal date.
In most cases, estimating the future benefits of owning an operating business are typically complex matters to assess and quantify: As such, the business appraiser needs a broad understanding of relevant economic and industry factors, capital market conditions, business management, and accounting.
Market Approach
As for the market or sales comparison approach, the real estate appraiser will seek data on sales of comparable properties, and the business appraiser will seek data on transactions of comparable businesses. The Odessa business appraiser will interpret the transaction data for guidance in determining applicable valuation parameters. Certain methods utilizing the market approach determine a small company in Odessa’s value by applying revenue, earnings before interest taxes depreciation and amortization (EBITDA), or sellers discretionary earnings (SDE) multiples to the subject company’s revenues, EBITDA, or SDE.
The only “quick and dirty” method to value a small business in Odessa is called the “rule of thumb” method. This method is a mathematical formula developed from the relationship between price and certain variables based on experience, observation, hearsay, or a combination of these, usually industry-specific. Rules of thumb are published each year by the Business Reference Guide. The NACVA states that small business indications of value derived from the use of the rule of thumb method should not be given substantial weight unless they are supported by other valuation methods, and it can be established that knowledgeable small business buyers and sellers in Odessa place substantial reliance on them.
Asset-Based Approach
The asset-based approach provides an indication of the value of a small business in Odessa by developing a fair market value balance sheet. All of the assets of the business are identified and listed on the balance sheet (note: this balance sheet is not the cost-based balance sheet that is prepared in accordance with generally accepted accounting principles), and all of the business’s liabilities are brought to the current value as of the valuation date. The difference between the fair market value of the assets and the current value of the liabilities is an indication of the business enterprise equity value under the asset-based approach. Generally, small businesses in Odessa are operating companies generating income for its owners. Therefore, small business buyers and sellers in Odessa place most emphasis on the cash flows generated through the continued operations as opposed to the underlying assets. It should be noted that this approach does not reflect the small business’s earnings capacity.
Summary
Each approach and underlying method to value a small business in Odessa requires unique attention depending on the specific circumstances. For example, an appraisal of a small business for lending purposes will not produce the same value in a litigation, merger, acquisition, or as part of an owner’s tax strategy.
