1.
The Income Approach,
2. The Asset Based Approach, and
3. The Market Approach. |
Within each of these
approaches there are many acceptable valuation methods available
for use by the appraiser. Appraisal standards suggest that an
appraiser may consider as many methods as may be applicable
to the facts and circumstances of the property being appraised.
It is then up to the appraiser's informed judgment as to how
these values will be reconciled in deriving a final estimate
of value.
The
Income Approach
The income
approach, sometimes referred to as the investment value approach,
is an income oriented approach rather than an asset or market
oriented approach. This approach assumes that an investor
could invest in a property with similar investment characteristics,
although not necessarily the same business.
The computations, using the income approach determine that
the value of the business is equal to the present value of
the future benefit stream to the owners. This is accomplished
by either capitalizing a single period income stream or by
discounting a series of income streams based on a multi-period
forecast.
Since estimating the future income of a business is considered
to be speculative, historic data is generally used as a starting
point in several of the acceptable methods under the premise
that history will repeat itself. The future cannot be ignored,
however, since valuation is a prophecy of the future.
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The
Asset Based Approach
The
asset based approach, sometimes referred to as the cost
approach, is an asset oriented approach rather than
a market oriented approach. Each component of a business
is valued separately, and summed up to derive the total
value of the enterprise.
The
appraiser estimates value, using this approach, by estimating
the cost of duplicating or replacing the individual
elements of the business property being appraised, item
by item, asset by asset.
The
tangible assets of the business are valued using this
approach; although it cannot be used alone as many businesses
have intangible value as well, to which this approach
cannot easily be applied.
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The
Market Approach
The market
approach is fundamental to valuation as fair market value
is determined by the market. Under this approach, the appraiser
attempts to find guideline companies traded on a public stock
exchange, in a same or similar industry as the appraisal subject
that provides the appraiser with the ability to make a comparison
between the pricing multiples that the public company trades
at and the multiple that is deemed appropriate for the appraisal
subject.
Another
common variation of this approach is to locate entire companies
that have been bought and sold in the marketplace, publicly
traded or closely-held, that provides the appraiser with the
ability to determine the multiples that resulted from the
transaction. These multiples can then be applied to the appraisal
subject, with or without adjustment, depending on the circumstances.
Liquidation
Value
Liquidation
value assumes that a business has greater value if its individual
assets are sold to the highest bidder and the company ceases
to be a going concern.
Shannon
Pratt, a well known authority in business appraisal states:
Liquidation
value is, in essence, the antithesis of going-concern value.
Liquidation value means the net amount the owner can realize
if the business is terminated and the assets sold off in piecemeal.2
He
adds,
...it
is essential to recognize all costs associated with the enterprises
liquidation. These costs normally include commissions, the
administrative cost of keeping the company alive until the
liquidation is completed, taxes and legal and accounting costs.
Also, in computing the present value of a business on a liquidation
basis, it is necessary to discount the estimated net proceeds
at a rate reflecting the risk involved, from the time the
net proceeds are expected to be received, back to the valuation
date.3
Pratt
concludes by stating:
For these
reasons, the liquidation value of the business as a whole
normally is less than the sum of the liquidation proceeds
of the underlying assets.4
______________________________
2 Shannon
Pratt, Valuing a Business: The Analysis and Appraisal of Closely
Held Companies, 2nd edition (Illinois: Dow Jones-lrwin, 1989):
29.
3 Ibid.
Small
Business Valuation Methods
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