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Choosing the right valuation method during an acquisition

On Behalf of | Jul 24, 2023 | Business Transactions

Business acquisitions can make or break the organization that is acquiring another company. The process of purchasing an existing company is a lengthy one that carries a massive price tag. Small oversights and mistakes can lead to massive financial setbacks or possibly the failure of the acquisition process or even the company attempting to buy another business.

It is, therefore, incumbent upon executives and others in positions of leadership at a company planning an acquisition to make sure that they handle the process very carefully. One of the most important considerations when acquiring another company is establishing the right price. Overpaying for another business could mean years of financial struggles for the business doing the purchasing. It is a challenge to establish what a company is worth, and choosing the proper method for business valuation is, therefore, very important during the acquisition process.

What are some of the most common choices?

The business valuation process involves looking at a company’s resources and debts, the condition of its assets and even what goodwill it has with the local community to calculate what the business is worth. Many of these factors are subjective and require current financial figures or market research to establish.

The business valuation process may look at current income, likely future revenue, projected growth and the value of existing assets, ranging from machinery to patents, to establish a reasonable fair market value for the organization. Some of the more common business valuation approaches include:

  • the discounted cash flow method
  • the market capitalization method
  • the earnings multiplier method
  • the times revenue method
  • the book value method
  • the going concern method
  • the liquidation value method

There are benefits and drawbacks to each approach, and factors ranging from what information the company proposing the acquisition can access to the industry in which the acquired business operates can influence the best method for business valuation.

Regardless of what method a company uses, being fastidious to avoid committing to an unrealistically high price and overpaying for a business is of the utmost importance. Discussing the acquisition process with a legal professional who is familiar with complex business valuation can help to take some of the guesswork and uncertainty out of the process.