July 26, 2016
We used to make elaborate valuations to clients, sometimes using 6-8 different methods to value a business. Some clients need this sophistication and are willing to pay for it. However, there are really three main ways to value a business.
The first one is the market-based valuation. Based on a multiple of a metric, which could be revenue, net profit, EBIT (Earnings before Interest and Tax) and most frequently EBITDA (EBIT plus Depreciation and Amortization). EBITDA is the best proxy for cash flow and banks and private equity groups love it.
The second method is the discounted cash flow based valuation, which determines the value of the business as the sum of the present values of its projected future cash flows. This is relevant when higher than the market value.
The third way is replacement cost valuation, which works as a sanity check for the investor, to make sure they don’t overpay.