Business owners must face the possibility that someday the enterprise will need to be taken apart. Large companies may divest themselves of business units that are not generating sufficient revenue. Small companies are often broken up when there are management disputes or cash-flow problems or when an owner decides to retire or be bought out. One of the greatest difficulties is determining the company’s breakup value — that is, its market value if parts of it were to be sold off. Business breakups sometimes end up in litigation, in which case the court must assess the breakup value.
In general, breakup value is based on what each business unit would be worth if it were separated from the parent company. However, this calculation is not as simple as comparing assets to liabilities. Especially for a small, privately held company, much of its value lies in intangible assets like goodwill, brand recognition and intellectual property. There is no uniform business valuation formula, but here are some generally recognized valuation methods:
- Market capitalization — This is simply a measurement of a company’s stock price. This method works for large, publicly traded holding companies that have individual business units.
- Asset valuation — The total value of all of the company’s assets (minus any associated debts) is computed. This model usually works best for companies that depend much more on hard assets than client development or marketing.
- Relative valuation — With this method, the financial performance of the business is compared with other similarly situated companies. This model is often used in industries with many competitors who publish detailed financial information.
- Discounted cash flow — This method calculates the business unit’s expected cash flow over a short or medium time frame. The cash flow is then discounted at a rate based on market risks.
- Replacement value — The company’s operational-related assets are assigned a value based on what it would cost to replace them.
- Earnings multiplier — The company’s price-to-earnings ratio is adjusted to account for current interest rates.
- Discretionary earnings — Often used for small businesses, this method takes gross earnings and adjusts them to account for non-operating and non-recurring income and expenses as well as for depreciation, amortization and interest expense.
An experienced business litigation lawyer can advise on the best valuation method to use for your company. The choice of method is subjective and sometimes leads to contention among the business owners, especially during litigation. Each side will generally retain their own expert evaluator. A combination of methods can be used depending upon the type, size and condition of the business.
H. Clay Parker, Esq. in Orlando, Florida has wide experience in all aspects of commercial law and litigation. We provide each client with the time and attention required to achieve optimal results. If you have a business valuation or other commercial matter requiring legal support feel free to contact us online or call [l for a consultation.
