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3 Methods for Determining Business Valuation

Business valuation goes beyond simple mathematics, but to get some idea of what your business might be worth, consider the three methods below.

Your landscape contracting business is likely your largest asset, so it's normal to want to know what it’s worth. The problem is: some people might consider business valuation a subjective science.

The science part is what people go to school to learn: you can get an MBA or a degree in finance, or you can learn the theory behind business valuation and earn professional credentials as a business valuation professional.

The subjective part is that every buyer's circumstances are different, and two buyers could see the same set of company financials and offer vastly different amounts to buy the business.

This article provides the basic science and math behind the most common business valuation techniques, but keep in mind that there will always be outliers that fall outside of these frameworks. These are strategic sales, where a business is valued based on what it is worth in the acquirer's hands.

Strategic acquisitions, however, are the rarest type of acquisition, so use the three methods below to determine a realistic value for your landscape contracting company.

Assets-Based Valuation

The most basic way to value a business is to consider the value of its hard assets minus its debts. A landscaping company will likely own trucks, equipment, trailers, etc. These hard assets have value, which can be calculated by estimating the resale value of your equipment.

But this valuation method often results in the lowest value for your company because it assumes your company does not have any "Good Will." In accountant speak, "Good Will" has nothing to do with how much people like your company; Good Will is defined as the difference between your company's market value (what someone is willing to pay for it) and the value of your net assets (assets minus debts).

Typically, companies have at least some Good Will, so in most cases you get a higher valuation by using one of the other two methods described below.

Discounted Cash Flow Valuation

In this method, the acquirer is estimating what your future stream of cash flow is worth to them today.

They start by trying to figure out how much profit you expect to make in the next few years. The more stable and predictable your cash flow is, the more years of future cash they will consider.

Once the buyer has an estimate of how much profit you're likely to make in the foreseeable future, and what your business will be worth when they want to sell it in the future, the buyer will apply a "discount rate" that takes into consideration the time value of money. The discount rate is determined by the acquirer's cost of capital and how risky they perceive your business to be.

Rather than getting hung up on the math behind the discounted cash flow valuation technique, it's better to understand the drivers of your value when you use this method. They include:

  1. How much profit your business is expected to make in the future
  2. How reliable those estimates are

Note that business valuation techniques are either/or and not a combination. For example, if you are using the Discounted Cash Flow method, the hard assets of the company are assumed to be integral to the generation of the profit the acquirer is buying so they’re not included in the calculation of your company's value.

A money-losing landscape company sitting on a $500,000 piece of land is going to be better off using the Asset-Based Valuation method. A professional services firm that expects to earn $500,000 in profit next year, but has little in the way of hard assets, will garner a higher valuation using the Discounted Cash Flow method or the Comparables technique described below.

Comparables Method

Another common valuation technique is to look at the value of comparable companies that have sold recently or for whom their value is public.

For example, accounting firms typically trade at one times gross recurring fees. Home and office security companies trade at about two times monitoring revenue, and most security company owners know the Comparables technique because they are often getting approached to sell by private equity firms rolling up small security firms.

The problem with using the Comparables method is that it often leads owners to make an apples-to-bananas comparison. For example, a small landscape company might think that because GE is trading for 20 times last year's earnings on the New York Stock Exchange they too are worth 20 times last year's profit.

Small landscape companies are deeply discounted when compared to Fortune 500 businesses, so comparing your company with a Fortune 500 giant will typically lead to disappointment.

Finally, the worst part about selling your business is that you don't get to decide which methodology the acquirer chooses. An acquirer will do the math on what your business is worth to them behind closed doors. They may decide your business is rare and a strategic acquisition. But in most cases, an acquirer will use one of the three techniques described here to come up with an offer to buy your business.

Curious to see what your business might be worth? Get your personalized Value Builder Score by contacting us today!

TAGS: Business Tips, Business Practices, Business Valuation, Business