We are now down to our final method for valuing a business. The capitalization of current net earnings valuations (CAP). This approach in valuing your business is based on what the company has proven it can earn. Of course, there is a “future” factor here as well. The expectation will be that the current rate of actual earnings of the company will continue for some time. The payoff for the buyer, they can increase those earnings to greater and greater levels through their efforts after they take over the business. This is the future opportunity factor which will be part of the purchase attraction for any buyer.
The Investment / The Business Owner
CAP is a powerful way of valuing a business which allows it to be fairly evaluated as an investment opportunity without many of the uncertainties that other valuations methods introduce. This method assumes that business owners are entitled to a fair return on the value of the business (their investment) over and above their fair wage if the owners work in the business. The approach is also known as the Excess Earnings Method. The Small Business Administration (SBA) recommends a form of this approach for establishing a business valuation as this approach works equally well whether the business to be purchased is operating as a sole proprietorship or as a corporation.
Getting to the Actual Value of the Business
Once a gross valuation is determined using the capitalization method, all of the assets will be physically listed with an approximate liquidation value apportioned to them (except for inventory, if any, which will be separately valued). This, less any contingent debt, constitutes the overall valuation of your business. You should understand that the difference in price between the valuation using the capitalization of net profits methods, and the fair-market value of the tangible assets of the business, is assigned to the intangible assets of the business, collectively referred to as the goodwill. This procedure automatically accounts for the value of all tangible and intangible assets without actually considering them individually. It assumes that the business assets are just the tools of the trade than enable the earnings stream to be realized. Without an earnings stream, a business essentially has no value as a going concern. When using this method, a business may actually be worth less than its asset value, or in some cases worth substantially more. You can get the most for your business by showing a buyer the investment value of your business. In most cases, buyers will pay the capitalization of net profit valuation of a business rather than its asset value (even if the asset value is substantially lower). It’s much harder to get buyers to pay the asset value of a business if a reasonable return on investment is not available.
The other valuation articles in this series are as follow:
- Part 1 – Understanding the Asset Based Valuation
- Part 2 – Market Comparison Valuation
- Part 3 – Present Value of Future Earnings Valuation
About Lisa Sharp – Based out of Pensacola, Florida, Lisa has worked in commercial real estate since 2000 and specializes in business brokerage and commercial sales and leasing. Her experience as an owner and operator, of multiple businesses, makes her especially qualified to help clients purchase and sell businesses. Click here to read her full bio, or if you would like to contact her, you can call her at 850-434-7500, or email her at [email protected] You can follow her on Twitter at @lsharpsvn.