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Business Valuation


Clearly, if you plan on buying a business the market price should be paid. In order to maximize your return, you wish to buy “low” and sell “high”. In a competitive market, there would many other buyers trying to buy such a business and there would be potential sellers of similar businesses to attract your investment dollars.  As a result of the competitive bidding process, the price paid for that business would be the fair market price.

However, businesses are not as generic as commodities such as pencils which are an undifferentiated product. Whether you buy a pencil from Walmart or one from Staples will not incur great risk; the two will be very similar in price, form, and function.

Let’s look at something a little more differentiated; residential housing. If there are five houses on sale on your street, the offered sale prices would likely vary significantly, reflecting the age, size, improvements and general condition. You would not wish to pay a similar price for each of these houses just because they appear to be similar properties from the street view.

A business is even more differentiated than residential housing, with many more variables to be considered in the buying decision. These variables, depending on the type of business could include, price, inventory, the size, stability and demographic profile of the customer base, the competitive landscape, the outlook for the particular industry etc. Thus, determining the correct valuation requires much more due diligence and sophistication than in the case of pencils or residential property.

How do we go about arriving at a valuation? One popular valuation method relies on taking a multiple of a metric of the firm, and this is what I will focus on.


Following my discussion, you will:

-          Have the knowledge and resources to apply the multiple method in valuation

-          Be aware of the various multiples that can be used

-          Be aware that no single technique should be employed in the valuation of a business or asset

-          Have a framework for reconciling results from different techniques

-          Be able to look for the types of factors that can significantly alter valuations of differentiated entities


The video discusses ONE technique – the “multiple” method. See

Steps for valuation using the “multiple” method are:

  1. First compute sustainable profit. In the video example, the sustainable profit = 100 (sales) – 70 (expenses) – 20 (owner salary) = 10
  2. Determine  an appropriate multiple for the business by consulting an expert or extracting it from a database
  3. Multiply the sustainable earnings by the multiple to obtain the valuation. In the video example, the valuation = 10 (sustainable earnings) x 3 (multiple) = 30

NOTE: The multiple depends on many factors including profits, the industry, customer base, expected growth rate, potential litigation and so forth. The following provides a link to resources for valuation multiples:


Clearly, using the correct multiple is critical. Find the multiple of a company that most closely resembles the one you are valuing, and then apply that to your sustainable profit.

Other Common Multiples

There are other multiples popular amongst certain industries; for example Price/Earnings, Price/Book Value, Price to Sales, or PEG (P/E ratio divided by earnings growth rate). Note that Price/Earnings is commonly used to value stocks as well. You can use the multiples technique for varying various asset classes.

Important Points

No single methodology should be relied on. Many techniques should be used so that the value that each gives can be checked against that yielded by another technique. If there is wide disparity amongst results, this could be due to improper computation, improper assumptions, bad data or the fact that a particular technique is unsuited for the purpose. An example would be when a company is so unique and new that it is not possible to apply the earnings multiple technique; the company may not yet have positive earnings and/or a comparable company may not exist on which to base the multiple.

Another important valuation technique is the DCF (discounted cashflow method) which can be discussed in another segment. The DCF discounts to present value the non-constant future cash flows and the constant future cashflows (when the growth rate is stable). The sum of the present value of both types of cashflows gives the price to pay. Whichever technique is used, remember that it keys off earnings directly or indirectly (linking with metrics such as sales, customers that will in some way lead to greater cashflow, and/or earnings).


The valuation of a differentiated product is no easy task. I focused on the “multiple” valuation technique, specifically a multiple of sustainable earnings. Multiples of different metrics can also be used. A sophisticated technique as an alternate to the “multiple valuation” method is the DCF model which discounts future cashflows. All models center directly or indirectly on the cashflow and/or profit the asset produces or has the potential to produce. No one technique should be relied on; rather, a set of valuation models should be utilized and their differing results compared and reconciled to reach a “consenus”.

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