Can I Use Rules of Thumb to Value My Company?

Industry rules of thumb used by business owners to determine the value of a company usually give misleading results. Rules of thumb are formu­las based on industry averages of companies sold using their sales price compared to either annual sales revenues or profits. As such, the actual sales price of an individual company is either higher or lower than the average. Seldom does a company's value fall right on the average. Furthermore, the value determination for a company up for sale will be different than the value determination made for purposes of divorce or for an estate tax calculation. These distinctions relate to the purpose of a val­uation, which affects methodology and certain assumptions made by the valuator. All these distinctions impact value determination.

Do Values of Privately Held Companies Correlate with

Values of Public Companies?

How Much Time Does It Take to Prepare a Business Valuation?

To perform a thorough analysis, make a qualified value determination, and prepare a proper report communicating the results of the business valuation easily requires 40 to 60 hours of work. Peculiar circumstances such as difficulties obtaining needed information, a unique and/or spe­cialized industry, or a litigious situation requiring special care and prepa­ration will often require more time to prepare the valuation.

Values of privately held enterprises are generally not comparable to publicly held enterprises for at least two distinct reasons. One: There is not a ready market of investors to buy stock in a private company. As such, in the value determination the valuator oftentimes deducts a "Lack of Marketability Discount" from the company value determined to adjust for the cost required to take a company public and/or sell the business through a broker. Two: Most privately held companies are much smaller in size than public companies. This increases the risk of ownership, or investment, in the enterprise. Consequently, the expected rates of return used by an investor, or prospective owner, to value a pri­vately held business are typically higher than returns anticipated with ownership in a public company.

Is Book Value a Good Indicator of Company Value?

Book value is almost never a good indicator of the value of a business, and usually much lower than the true value. Book value generally reflects only the cost of the company's tangible assets net of depreciation and liabilities, ignoring appreciated asset values and company intangible values such as goodwill.

Can I Really Expect to Receive Much Value out of My Company When I Retire?

Historically, owners of private companies have looked to cash flows and tangible assets for company value, with little consideration given to the goodwill of the enterprise. Consequently, at retirement they get less value than what otherwise might be possible, by selling only the tangible assets of the business or simply liquidating inventories and closing their doors. The fact of the matter is, much of America's wealth is tied up in privately owned companies and is attributable to business goodwill. These observa­tions are further supported in a study of privately held companies conduct­ed by Robert Avery and Michael Rendall at Cornell University and refer­enced by the Wall Street Journal in June 1996, with the following quote: "The greatest transfer of wealth in history will occur in this country over the next decade; an estimated $10 trillion is expected to change hands, and much of this wealth is tied up in family business stock."