Business Valuation Basics 101
Back To Basics: Business Valuation In Singapore
It is important for a business owner to be clear of his/her objectives and goals when starting a business - this will help with the succession planning.
One common direction of succession planning is selling the business, which most owners would not think of initially, and then regret later, especially when their business picks up and offers start coming in.
A business owner can start with exploring options after selling a business to start understanding his/her objectives and goals. Then it is to find out the value of his/her business through a business valuation, which is a jumping-off point for any impending analysis - business or personal.
The important questions to consider for a business valuation is as follows:
● What is the business valuation for?
● What is the role of a business valuation in the process of selling a business?
● What determines the value of the business?
● How is the value of the business calculated?
● How can the business owner maximise the business value?
The Key Considerations Stemming From The Questions Above Will Be Further Discussed Below:
The 3 Main Purposes Of The Business Valuation
Generally, a business valuation is conducted for the following purposes:
1. To fulfill tax requirements
Businesses in Singapore have to pay a significant amount of government enforced corporate taxes - mainly on profits and income. It is important to be clear of the relevant numbers to work out the correct amounts of payable taxes, and avoid unnecessary payments and losses.
2. For exit planning (transactional)
In Mergers & Acquisitions (M&A), it is vital to be clear and transparent of the financial status of the business to facilitate options like a transfer of ownership and/or employee stock ownership and purchase price allocations.
3. For litigation
During a divorce or when there are disagreements amongst the shareholders, there is a need to work out the value of individual ownership and contribution for a fair compensation or return on investment.
Here, a business valuation helps to work out the damages or facilitate a fair buy-sell agreement.
The 5 Types of Values and Their Standards
1. Fair Value
This the price received from selling an asset or the payment for transferring a liability, which must happen through an orderly transaction involving the ‘actual’ market participants within the measurement date.
Based on the litigation perspective, this value is like ‘a restore to equity using valuation at an enterprise level’. Hence it does not include discounts for the minority shareholders or the lack of marketability.
2. Liquidation Value
This refers to the money received when a business is broken down into saleable assets. Though liquidation gives the lowest return on assets, its timing still has a significant effect on the overall business value.
This way of valuing is usually for defunct businesses going through a bankruptcy proceeding - or a bank-enforced liquidation.
3. Intrinsic Value
A buyer considers this value as the ‘true’ or ‘real’ value, which will eventually become the market value when other buyers also use it.
This value is usually derived from an evaluation of available facts relating to the target business.
When using this value, the benefit that comes with it is termed as ‘value to the holder’.
4. Fair Market Value
This is the ideal price of the target property based on a hypothetical willing buyer and seller.
This value is based on ideal circumstances where both parties have equal knowledge of the relevant information about the business; and there is no pressure or compulsion to sell and buy. Hence it is usually considered an unrealistic expectation in a real transaction.
5. Strategic Value
It is the value of a certain buyer based on his/her investment expectations and requirements. Hence it considers the ‘synergy’ of the investment, which involves new revenue potential, cost-out opportunities, scale economies and the buyer’s pride.
This value is unique to a buyer hence it can vary widely across different buyers.
The 3 Methods Of Determining The Business Value
1. The Asset Approach
This uses the business’s net asset value, which is the difference between assets and liabilities - or simply the equity value.
Also known as the ‘cost approach’, this method generally assumes that a business has no intangible value. Hence since intangibles - or goodwill - also drives value, this method becomes a strong indicator of the intangibles’ level of impact on the overall business value.
2. The Market Approach
This method uses a comparison between the business to a good sample size of comparable ones.
There are two ways to do the comparison:
● The Comparable Transaction Method (CTM)
Outside of Singapore, this is known as the Guideline Transactions Method.
This method focuses on the sale of the business to another potential buyer. It produces data valuable for the business valuation once the comparable transactions are identified - one of the challenges in using this method.
● The Public Company Guidelines Method (PCGM)
This method compares the target business to the transactions of a comparable one that are published in the stock market transaction details.
This method is less viable for privately owned businesses since data of private businesses are hardly accessible to the public.
Hence when using this method, valuation experts would tend to use market-based multiples like the earning ratio, and then adjust it based on the differences in the potential level of growth and risk between the target business and its comparable one.
3. The Income Approach
In this method, the value of the target business is estimated based on its expected future cash flow or operating income - a representation of its present value.
Hence the mathematical formula is:
Cash Flow (current year) + Discounted Projected Cash Flow (future)
It becomes clear that the two main variables of this estimation is: (1) the discount rate; and (2) the earnings of the business.
The discount rate speaks for the ‘cost of capital’ - which is a cut of the future stream of payments by an appropriate rate of return.
This method is agreed amongst many experts to be the most accurate method of working out the business value as it is based on the business’s expected returns.
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