“Business valuation is simple and much like property valuation” – this is a common misconception, but the reality is far from this. Business valuation is a specialised field and so is property valuation, but both are very different although the broader valuation concepts are the same. Let’s look at this in more detail in this article from the point of view of business valuation.
Any business or property, in general, can be valued using one of the 3 valuation approaches. These being, market; income; and cost.
Both business and property follow the basic premise of any investment. Refer to the figure below:
In general, the higher the potential return of an investment, the higher the risk although, there is no guarantee that one will get a higher return by accepting more risk. There are various classes of potential investments, each with their own risk-return profile. The general progression is: short-term debt, long-term debt, property, high-yield debt, and equity (i.e., an investment in a business). Businesses tend to provide the highest rate of return and are more complex than other potential investments, hence more complex to value.
The nature of businesses is such that no two businesses are very similar. This aspect is discussed further below. Two properties of similar size in similar location may not differ so much in value as the land value tends to be a more stable measure for comparison and the variable part can be the building/ structure. So, in general, the comparison between two properties tends to be relatively simpler than comparing two businesses.
A business can be perceived as a pool of income generating assets including, fixed assets, sometimes property/ real estate, working capital and intangible assets such as goodwill and brand/ tradename, customers, software, patents, etc. This pool of income generating assets work together to make the business tick. A business valuer needs to be cognizant of these if not valuing these assets individually.
Then there are many other aspects in a business to be considered, including – people/management, product/service, customers, suppliers, market position, competitors, industry growth and future trends, technology, R&D, regulation, environment, financial performance and strength, taxation, etc. As such, there are many different aspects to a business and by its nature, a business is more complex and tends to be harder to value and more time consuming than a property, in most cases.
Two businesses operating in the same/ similar industry with similar size could have widely different business values.
Let’s look at a real-life example, names not disclosed for obvious reasons! Two businesses are of similar size, but one is valued at almost 30% more. You may ask why and it’s a perfectly valid question! One of the businesses has better:
- quality of customers i.e., bigger customers who entered into medium to longer term contracts on better terms, pay on time and bad debts are limited
- quality of management and they are working on future proofing the business and have invested in technology in a big way to stay relevant
- profit margin due to the quality of customers, use of technology, etc.
These are only some of the differences and usually there are many more.
Let’s look at some key differences for business valuation vs property valuation:
- Not easy to compare one business to another as highlighted above
- Not easy to access financials of private companies whereas property values are more readily available
- Not easy to find sales data for business valuations. This is generally not the case for properties
- Asking price of businesses is more meaningless (can be ridiculous sometimes!) than the asking price of property
- Financial statements most of the times need to be adjusted for business valuation
- Business value is impacted by numerous factors as highlighted above and does not always increase over time
In conclusion, both business valuation and property valuation are specialised fields. However, due to the nature of businesses and the many different aspects to be considered, business valuation tends to be more complex. A valuer needs to spend time understanding the business, otherwise there is always the risk of over-valuing or under-valuing something if it is not properly understood.
By Adie Gupta
This article has been authored by Adie Gupta, the Co-Founder and Managing Director of Spring Galaxy. Adie has been providing valuation and strategic advisory services to the corporate sector and government agencies across the Asia Pacific region for more than 20 years. He is a regular trainer for accounting bodies, business schools, angel networks as well as speaks at various conferences and other forums on valuation and IP.