When valuing a family business, an analyst considers, among other things, the company’s assets. These include tangible assets reflected on the company’s balance sheet, as well as intangibles such as firm culture and the strength of the management team, both current and the next generation.
So how do intangible assets such as the culture of a family business affect its business valuation?
To answer that question, it is helpful to first take a look at the general mechanics of a business valuation. When valuing a business, there are three basic approaches: asset, market, or income methods.
The market approach compares certain metrics of your business to those of publicly traded companies in a similar industry or to metrics of recent private transactions. It is rare to find public companies that correlate with private companies due to their advantage of scale and access to more resources. Private company transactions often do not have enough data released about them to allow the analyst to make informed conclusions. Since it is difficult to correlate public companies and there is a lack of information available in a private transaction, the market approach is not often used.
The asset approach reviews the company’s balance sheet and makes adjustments either up or down based upon those values. Common adjustments include marking real estate up to its fair market value, or adjusting inventory for obsolescence and uncollectable receivables. The asset approach is often the baseline analysis.
The third, and most common, approach is the income method. The analyst evaluates income streams and attaches a multiple to those income streams. This is where the culture of a family business come into play. The multiple is nothing more than the sum of all the intangibles of the business. The intangibles include not only the predictability of the revenue stream, but also a company’s ability to protect it. Strength of the management team, next generation development, and family culture are the aspects that are evaluated here as well. How much time and effort a family firm invests in developing its management team and its next generation directly influences the multiple of the company – either up or down.
The investments made to develop key team members, including the next generation, invariably increase the value of a family business – whether or not they sell to an outside party. The more competent the team, the more effective the business is at generating and maintaining those cash flows. A committed culture helps drive the company forward, and ultimately increases the business valuation of the family firm positively.
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