Business Valuation: Definition and Methods

1.What is a business valuation and why do you need to value business?

1.1.Business valuation definition

Regarding the basic definitions in investment, we can ignore the definition of "business value". Business value is not merely the equity value of a business; but the value of all assets used in the operation of that business.

To evaluate the value a business can bring to investors, two values are considered:

• Liquidation value, which is all the money obtained when the business ceases to operate and sells all of its properties.
• Ongoing operations value, which is the present value of future cash flows, beginning with a company's operating activities.

With the above information, we can simply understand that:

“Business valuation is the determination of business value”

Business valuation is a prerequisite step before conducting business investment activities or mergers and acquisitions

1.2.Importance of business valuation

Normally, the business will be evaluated at the point of time when the owner decides to cease operations and sell their company. However, each business needs to have a certain display value at every valuation. Therefore, businesses will be valued at least once a year. The reasons for this are:

• Business valuation can help business owners in making faster decisions when unexpected scenarios happen. It also helps business owners to be more proactive in pricing, which retains benefits when they want to sell their business.
• Keeping the value updated over time allows business owners to benefit from opportunities to sell or merge into new businesses in a quick way.
• Taking more advantages when deciding to invite more shareholders or planning to equitize the business.
• Establishing credibility so that the bank can decide whether to lend the business or not.
• Easily building trust when the owner wants to find investors and customers.

2. Business appraisal standards

The standards for determining the value of a business are based on either market value or non-market value. The criteria used for business valuation are determined based on the standards for appraisal purposes, legal characteristics, economic-technical characteristics and market characteristics of the enterprise being valued, as well as the requirements of customers in the valuation contract (if it aligns with the purpose of the valuation) and relevant laws.

Based on the actual potential and the operating market of the business, valuation purpose and legal provisions, the appraiser will give an assessment of the operating and transaction status (actual or hypothetical) of the enterprise after the time of valuation. Generally, the value of the business is the ongoing operation value. In case the appraiser concludes that the enterprise will cease to operate after the time of valuation, the enterprise’s value will be the value of operating with a definite term or the liquidation value.

The application of business appraisal methods should align with the enterprise value standards and the appraiser's assessment of the enterprise’s operating status during and after the time of valuation.

The standards for determining business value is either market value or non-market value

3.Business valuation methods in Vietnam

3.1.Mean ratio method

The mean ratio method estimates the equity value of a business and assesses the value based on the average market ratio of the companies being compared.

The comparable companies are those that satisfy the following specific conditions:

• Having similarities with the businesses that need to be valued in several factors such as main business line, financial risks, business risks or public financial indicators.
• Having information about the shares that have been successfully traded on the market at the time of valuation. This may include information about the shares that have been successfully traded near the appraisal time but not more than 01 year from the time of appraisal.

In this business valuation method, the market ratios considered in the business valuation formula include: price-to-earnings ratio; price-to-sales ratio; price-to-book value of equity; ratio of equity value to earnings before interest, tax, depreciation or amortization; equity value-to-sales ratio…

MMoreover, to apply the average ratio method for business valuation, it is required that there are at least 03 comparable enterprises, with priority given to those listed on the stock exchange.

3.2.Transaction value method

The method of business valuation based on the transaction value method is an appraisal method that assesses the price of successful transfers of contributed capital or shares on the market of the enterprise being valued.

This business valuation method is applicable to enterprises with at least 03 successful transactions of transferring capital contribution or shares on the market. Furthermore, the transactions should have occurred no more than 01 year compared to the time of valuation.

Regarding the principles of applying the transaction value business valuation method, the appraiser needs to evaluate and consider adjusting the price of the successful transaction to be appropriate for the appraisal time if necessary.

The most common methods of business valuation include average ratio-based, transaction value-based, asset-based, and discount-based.

3.3.Asset-based business valuation method

This is the business valuation method that appraises enterprises by calculating the total value of assets owned by the business.

The principles of this valuation method are as follows:

• Assets taken into consideration during the appraisal contain all assets of the business, including operating and non-operating assets.
• When valuing an enterprise on the basis of asset value, the assets are valued at the time of valuation, the assets in the accounting books are appraised at their market value.
• Intangible assets that do not satisfy the conditions to register in the accounting books require an appropriate valuation method.
• Assets accounted for in foreign currencies should be valued in accordance with the guidance of Vietnamese Accounting Standards.

3.4.Discount-base business valuation method

• Discounted free cash flow valuation method

This business valuation method requires an estimate of the sum of the discounted free cash flow value of the business with the present value of non-operating assets at the time of appraisal.

If the enterprise is a joint-stock company, the discounted cash flow business valuation method is used assuming that the company's preferred shares are valued the same as common shares.

• Discounted dividend stream method

For enterprises that are joint stock companies, this method will be used with the assumption that the preferred shares are equivalent to common shares. This method of business valuation needs to be done through many steps with many different specific cases. There are different ways of valuing the business, depending on the status of the business as well as the type of company

• Discounted free cash flow of equity method

This method of business valuation calculates the sum of the enterprise’s discounted free cash flow of the equity.

In the case the enterprise being appraised is a joint stock company, this valuation method will assume that preferred shares are equivalent to common shares.

Conclusion

INMERGERS hopes that the above article has helped you understand the definition and importance of business valuation and how to value a business. Join MMatch - the business trading platform of INMERGERS to connect with potential businesses, and investors and receive legal advice to maximize profit from your investment.