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Factors to be Considered in a Business Valuation

9 December, 2015 - 12:23

Whatever the technique, the analyst should consider a variety of factors about the business and its industry. Among the factors to be considered are the following: 1

  • What is the stage of the company’s development? Is it new, established and growing, mature, or declining?
  • What is the current and prospective state of the industry in which the company operates, and of the economy in which it competes? How attractive is the industry to capital suppliers?
  • What is the experience and competence of the members of top management and the company’s Board of Directors?
  • What is the company’s position in the marketplace—for example, its market share—and what major competitors does it have?
  • Are there barriers to entry in the company’s marketplace?
  • What are the competitive forces in the company’s industry (recall Porter’s five competitive forces, discussed in an earlier chapter)?
  • Does the company have proprietary technology, products, or services, and what is the nature of the protection, such as patent rights or exclusive licensing?
  • What is the nature and quality of the company’s work force, including employer–employee relations, pay and benefits, labor supply, and the like?
  • What is the nature and quality of the company’s suppliers and of the company’s customers? Is the company dependent on a small number of customers or vendors, or does it have a broad base? Are the customers and suppliers financially solid?
  • Are there strategic relationships with suppliers, customers, and sources of financing? The existence of such relationships may be a positive or a negative factor when valuing the company.
  • What is the company’s cost structure (operating leverage, fixed-variable mix) and its financial strength indicated by debt capacity, free cash flow, and the like?
  • What risk factors does the company face?

The consideration of risk factors is an especially important part of business valuation. Uncertainties or concerns in any of the above areas may signify risks to be considered.

Two simple approaches to business valuation are (a) determining the value of the company’s net assets (assets minus liabilities) and (b) identifying the fair market value of a similar business. We discuss them briefly in the following sections, although they often prove unsatisfactory.