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• Eliminate the owners‟ nonbusiness expenses and perquisites (increases cash flows and
lowers a buyer‟s risk of inaccurate financial information).
• Report all revenue on the financial statements and tax return (increases cash flows).
• Develop a team of qualified managers for the possibility that the current owner(s) may
leave the firm upon a sale (lowers buyer‟s risk of earnings volatility and other uncertainties).
• Plan for the current owner-managers to continue working for the firm under new
ownership for a fixed period (lowers buyer‟s risk of earnings volatility and loss of customers,
employees, and vendors).
• Have the firm‟s annual financial statements audited or reviewed by a certified public
accountant (a chartered accountant in some countries), and improve interim financial reporting
(lowers buyer‟s risk of inaccurate financial information).
• Develop a list of possible strategic buyers (search for buyers willing to pay a higher price
for unique synergies between the buyer and the target firm).
• Decrease dependency on major customers and vendors (lowers buyer‟s risk of earnings
volatility in the event of the loss of a key customer or vendor).
• Develop and organize business data that would be needed by potential buyers (lowers
buyer‟s risk of perceptions of potential earnings volatility without having such knowledge).
• Improve any current financial statistics or ratios that are poor (lowers buyers financial
risk).
Public firms report their earnings and performance at least quarterly, and the share prices often react
quickly. Values of private firms usually react more slowly to changes. Thus, managers of private firms
may need to start working on value improvements one to two years before selling a firm.
Summary
The fair market value of a private firm is essentially an estimate of the price that a willing buyer
would pay and a willing seller would accept. Buyers have different motives for buying a business.
Financial buyers look for a return on their investment. Strategic buyers often look to integrate their
firm with the target firm for strategic reasons. Theoretically, financial buyers pay fair market value,
whereas strategic buyers often pay a higher price that reflects synergies.
Although it seems possible to quickly value a private firm by simply plugging numbers into a
discounted cash flow model or applying a price multiple to the firm‟s historical earnings, the question
remains whether the resulting value is indeed reliable. Many variables go into a valuation analysis,
and those variables often require lots of work to develop. Most private firms have much less
information readily available than public firms have. A business valuation analysis is both a
quantitative and a qualitative process that is mostly focused on evaluating investment risk and
investment return. It is largely an assessment of the risks an investor is taking on by acquiring and
owning the firm. In addition, a valuation analysis often attempts to forecast the earnings an investor
can expect to receive in the future as a return on investment.
Author’s Note: This chapter is not intended to be a complete discussion of business valuation. It is
meant to illustrate many of the fundamental ideas of business valuation and their application through