Another way to value a business is to figure out which valuation method is most commonly used in your target industry, and then take it a big step further and ask industry participants for their input on valuation.
The Industry Research Approach Is Particularly Appropriate For Middle-Market Businesses
I think this approach is particularly useful for middle-market companies with sales of $2 million up to several hundred million. Over that amount, I’d start with the valuations of public companies and then apply a discount to the private company for being both private and less liquid, and then if appropriate for size and for the particular situation.
For companies under $2 million, I would generally rely on a simple multiple of earnings approach. However, I might also use the industry approach as a ceiling for what I would pay.
Successful Business Valuation Example
In the book I published by Russell Robb, Buying Your Own Business, he talks about how he used this approach. He said that although he was not a professional business appraiser, he was retained from time to time to value a company. He recalls one episode where a plumbing supply distributor had to be valued because of the owners’ impending divorce.
This distributor’s sales had deteriorated from $8 million to $4.3 million in just a few years, and profits had gone from positive to negative. The company carried well-known original equipment manufacturer (OEM) product lines, and at one time had had six branch outlets. It had been one of the leading plumbing supply houses in New England.
Related: Business Valuation Basics
The divorce was headed for court, and Robb was to be one of the key witnesses for placing a value on the couple’s business. He notes he was not a member of either the Institute of Business Appraisers or the American Society of Appraisers, and, in fact, humbly said his entire educational credentials were “suspect.”
He was, however, a “somewhat seasoned” business intermediary who had sold three of his own businesses. In fact, as you can see, I think you’ll find his approach was unusually astute and likely better than one a “professional” appraiser might use.
All this hoopla, he said, is not about how difficult this valuation assignment had become, but simply about how to approach a valuation when one does not have the appropriate experience as an appraiser. The method he used in preparing his written valuation was so simple, he says, that it was “just a matter of common sense.” His client was well known in the plumbing supply business, having served on the board of the National Plumbing Supply Association. Working in conjunction with him, Robb called more than 20 owners of other plumbing supply distributors.
He asked them if they had bought or sold any similar businesses and to share with him their knowledge as to the basis of their valuation. Inasmuch as plumbing supply distribution is similar to most other distributorships, 85 percent of the assets were in either inventory or receivables. Furthermore, it is a personal relationship business, with both vendors and customers having virtually no long-term exclusives.
He documented every conversation and came to the conclusion that his client’s business was worth book value, plus a 10 percent goodwill premium, on the condition that the inventory and receivables were fairly current.
Although Robb’s approach is excellent, I think he is modest in calling it “simple” because it takes a lot of work. And I would particularly caution you on using such an approach if you are only willing to reach out to one or two industry insiders who are willing to give you their perspectives on valuation.
Takeaways You Can Use
- Different industries often have one valuation method that is more commonly used than others.
- Industry-standard valuation methods are usually not appropriate for very small companies.
- Industry research is not simple; it takes time and a lot of industry sources.
- The research can help you set a ceiling for what you would pay.