Company valuations

Ross Woods, rev. Oct. '13. Rev. '18

 

We have seven different kinds of company valuation:

Kind of company valuation Comments Example
Agreed value
An agreed value is the value that the buyer and seller agree on.		 It is a nominal value in that there is no evidence for it in the accounting documents (e.g. balance sheet, recent share sales). WXYZ Corp. offers its shares for sale at $10, with a condition of purchase that buyers agree that it is a fair price.
The book value
The value of tangible assets minus liabilities (i.e. the balance sheet value minus intangible assets).		 This approach is best when intangible assets are difficult to value or sell. The MNO company has $700,000 in tangible assets and liabilities of $200,000. Its book value is $500,000.
The balance sheet value A
The balance sheet value is the equity shown on the balance sheet when it lists both tangible assets and intangible assets.		 This approach is better than book value when intangible assets are high quality (e.g. strong trading goodwill, IP companies). The MNO company has $700,000 in tangible assets, $300,000 in intangible assets, making its total assets $1,000,000. It has liabilities of $200,000, making its equity (balance sheet value) $800,000.
The balance sheet value B
The balance sheet value is the equity shown on the balance sheet when it lists tangible assets and externally generated intangible assets but not internally generated intangible assets.		 Under some accounting standards, the balance sheet is not permitted to include internally-generated intangible assets. This approach gives an inaccurate valuation if the organization has a large internally-generated asset, such as a very strong brand or its own patentable inventions. The MNO company has $700,000 in tangible assets, $250,000 in externally-generated intangible assets, and $250,000 in internally-generated intangible assets, making its total assets $1,000,000, but this only shows as $750,000 on the balance sheet. It has liabilities of $250,000, making its equity on its balance only $500,000.
Profit
The sum of the net profit over a given period, usually the most recent two or three years.		 This is more like a simple rule of thumb. Its use depends on other factors. For example, it is quite appropriate for businesses with strong cashflow but few assets. It would be quite inappropriate for businesses with large amounts of saleable assets (e.g. property). XYZ Corp. made a net profit of $500,000 last year and $450,000 the year before. Joseph Blow, a prospective buyer, considers $950,000 a fair price to buy the company.
Adjusted value
The balance sheet value adjusted for:
  • Strengths of intangible assets
  • Current and projected value of tangible assets
  • Recent net profits
  • Projected future net profits
  • Amount of risk
  • Costs incurred to increase future net profits 		This is a combination of various other models.
Sum of the value of shares
The sum of the current market value of all shares owned by shareholders.		 Share values are normally based on the book value plus an amount based on anticipated profitability.
"Shares owned by shareholders" include shares owned by people upon incorporation and shares sold to shareholders. It does not include unissued shares owned by the corporation.		 If shareholders own 100,000 shares and the market value of each share is $20, then the value of the corporation is:
100,000 x $20 = $2 mil.
Trajectory mapping
Calculating the value by comparison with the growth of similar companies in the same (or similar) industries.		 Trajectory mapping is only used for startup companies. Billy Bloggs has a patent, a prototype, and a very firm business plan, but no other assets. The valuation company examined Billy's patent, his plan, and his ability to implement his plan. They then looked at the value growth of similar companies in similar industries with similar patents, and decided that it would be worth $10,000,000 in three years. However, they then substantially discounted this amount by 90% for risk, and approve funding as if the company would be worth $1,000,000 after the start-up phase.

 

On intangible assets and their valuation
The valuation of intangible assets is usually difficult and subject to various assumptions.

In general, there are two major kinds of intangible assets. The first kind are those that can be used to generate income. Some accounting standards allow all these to be included in a balance sheet, while other standards exclude those that are generated within the organization, regardless of their value. The second kind of intangible asset is those that do not directly relate to income. They are never listed as monetized assets even though they are usually a necessary pre-requisite to business.

  1. Patents can substantially boost company valuations if valuation includes IP.
  2. Intangible assets can be either transferable or non-transferable. (Transferable intangible assets include patents and trademarks because they can be sold. Non-transferable intangible assets include licenses, such as software licenses.)
  3. The value of many, perhaps nearly all, intangible assets can change over time, and, eventually they usually need to be amortized. It's possible that even the assumptions used in any valuation will change over time.
  4. Some have no market value and cannot normally be sold, so are not even included in the asset register and balance sheet as assets. e.g. documents used for organizational procedures.
  5. Licenses and accreditations might not be transferable but they might be valuable to those wanting to take over the business.
  6. The main value of some particular kinds of intangible assets is that they drive cash flow or are transferable. In some kinds of businesses, especially Internet companies, intangible assets can be worth much more than their tangible assets. Consequently, unsecured shares should eventually have a higher value than secured shares.
Examples of intangible assets:
  1. Intellectual Property: Trade marks, copyright, software, patents, patentable (or potentially patentable) knowledge, website, materials
  2. Computer data
  3. Registrations, institutional accreditation and licenses
  4. Business name
  5. Business processes
  6. Rights to use IP owned by third parties (materials, software, etc.)
  7. Documents used for organizational procedures
  8. Client lists
  9. Goodwill brought through trading
  10. Benefits of any contractual relationships when all debts have been paid e.g.
    1. client agreements,
    2. employee agreements,
    3. rights over franchisees and licensees,
    4. contractual obligations with employees regarding proprietary knowledge
Consider the interaction between tangible and intangible assets: tangible assets are used to generate intangible assets. E.g. the corporation pays programmers with money (tangible asset) to write software (an intangible asset). But then the software is used to generate cash income (a tangible asset).