As a business grows and expands, one of the many risks to prepare for is litigation and legal disputes. Sometimes, it is over intellectual property, a merger gone awry, or a shareholder disagreement.
If you’re already dealing with the complexities of running a successful business, the last thing you need is the added stress of litigation.
This is where business valuation services come in. A precise valuation can be the linchpin in litigation, influencing outcomes significantly. Harvard Business Review suggests that firms should conduct a detailed valuation at least once a year, before legal issues even arise.
But how do you determine the value of your business for legal purposes? Let’s explore the most common valuation methods.
Income Approach
The Income Approach is all about the money your company is expected to generate in the future. For larger companies with millions in annual revenues, this method often focuses on Discounted Cash Flow (DCF) analysis.
Essentially, DCF estimates the present value of future cash flows, adjusted for risks. The DCF method projects your company’s future revenue and then applies a discount rate that reflects the inherent risks of your industry and market conditions.
This approach is particularly useful in litigation when future earning potential is a critical factor, such as in wrongful termination or partnership disputes. It’s advisable to start with this method and work your way up.
Market Approach
The Market Approach compares your company to similar businesses that have recently been sold. This method is effective for litigation involving larger firms because it leverages actual market data, reflecting what investors are willing to pay for a business like yours.
This approach often employs metrics like Price-to-Earnings (P/E) ratios or revenue multiples from comparable companies. If, for instance, you own a tech firm, which generates millions annually, and is in a shareholder dispute. A professional can estimate your company’s market value by looking at recent sales of similar tech companies.
If similar companies are selling at a multiple of 5 times their EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), and your business has an EBITDA of $4 million, the valuation could be pegged at around $20 million.
Asset-Based Approach
The Asset-Based Approach focuses on the value of your company’s tangible and intangible assets. For larger companies, this might include everything from property and equipment to intellectual property and brand value.
This method is often used when your company is asset-rich but might not be generating high income. This method provides a clear picture of your company’s worth based on its physical and intellectual holdings.
To illustrate, if your manufacturing firm is facing litigation related to a dissolution, an asset-based valuation would look at the market value of your machinery, real estate, and any patents you hold.
Cost Approach
This approach assesses how much it would cost to replace your company’s assets. It’s less about what your company can earn and more about the expense involved in rebuilding it from scratch.
This method is frequently used for unique or specialized businesses where market comparisons might be scarce.
For a manufacturer, for example, in a lawsuit, the Cost Approach might evaluate what it would take to replicate your facilities, technology, and workforce. This approach ensures that the valuation reflects the significant investment required to recreate your business.
Hybrid Methods
Sometimes, a single approach is not sufficient to capture the full value of a business. Hybrid Methods combine elements from multiple valuation approaches to provide a more nuanced picture.
Large companies with diverse assets and revenue streams might need to use a hybrid approach.
For instance, a blended approach might incorporate both the Income and Market Approaches, giving weight to both future earnings potential and market conditions.
Navigating litigation can be complex, but understanding your business’ valuation can provide clarity and direction. At Cg, we specialize in helping companies like yours with business valuation services.
Visit our business valuation services page to learn more, or contact us directly for more personalized guidance. Let us help you understand your company’s value and advocate for your best interests.