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It has been said that estimating the value of a private business is similar to analyzing securities of
public companies. The theories are similar and not overly complex on the surface. There are even Web
sites that say they can value a private firm. But like so many things in the business world, the devil is
in the details. The valuation of a closely held business depends on many variables. While valuation
theory does not seem overly complex, the accuracy is only as good as the variables that go into it. The
valuation of private firms is often complicated by the quantity and quality of information and the way
private firms are operated. Unlike public companies, private firms often do not have complete and
accurate information available. Dollar for dollar, the time to value most profitable private firms is out
of proportion to the analysis of public company securities. This is shown in the following case study,
which illustrates valuation theory and types of information that are used.
For the past 20 years, Bob has owned and operated a manufacturing business that has grown
significantly since it started. Bob is 60 years of age, and his children do not appear capable of taking
over the company. He is thinking about the future of the firm at a time when he would like to slow
down. One of his options is selling his business. Bob‟s company, Acme Manufacturing, Inc., makes
certain types of adhesives and sealants and has revenues of approximately $50 million. It has six
plants throughout the country. Bob owns 100% of the firm‟s common stock. He does not know what
the business is worth, nor does he know how its value would be determined. Bob asked his accountant
about valuing the business. The accountant recommends that Bob hire someone who specializes in
business valuations. After interviewing several candidates, Bob hires Victoria to value his firm. The
valuation date is December 31, 2008, and the standard of value is fair market value. Victoria explains
the valuation process and the scope of her work.
Three Approaches to Value
Victoria tells Bob that the value of a firm is usually estimated by considering three approaches:
1. Income approach.
2. Market approach.
3. Asset (or cost) approach.
The income approach estimates a value by using a method to convert expected future economic
benefits, such as cash flows, into a present single amount. This approach is based on the concept that
the value of an asset—such as a stock or a business—is all of its expected future benefits expressed in
present-value dollars. (A simple example of present value is that a dollar to be received a year from
now is worth perhaps 95 cents today.)
Next, the market approach is a way of estimating a value by observing the prices of identical or
similar assets. For instance, real estate appraisals using the market approach often rely on the sales
prices of comparable properties. In business valuation, it is sometimes possible to observe prices of
similar firms that have been sold.
The asset approach is a way of estimating value based on the individual values of the firm‟s assets
less its liabilities. The firm‟s balance sheet serves as a starting point. This approach requires that all of
the assets be identified—even if they do not appear on the balance sheet. Often, a balance sheet does