Deals & Acquisitions
Feb 21, 2023
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This guide explains how to value a private company based on the asset valuation method. We will look at how asset valuations are determined, instances where they are helpful for private company valuation, how to determine what assets are worth, as well as the challenges to this method. Here are some key takeaways about private company asset valuation:
This guide is designed to familiarize you with the asset valuation method used to value a private company. For more information about how private company valuation works in M&A deals, we recommend this guide: Intro To Private Company Valuation. We recommend reading that guide before this one as that guide will help to put this one into proper context.
Here, we will briefly outline the four most common methods used in private company valuation:
Each of these valuation methods will give us a price point that makes sense from the perspective of how each valuation works. Remember, the goal in business valuation is not to come up with an exact number. In practice, normally several valuation methods are used to give a price range that might make sense to pay for a business. From there negotiations can begin. To learn more about this and the rationale behind each of these methods, we recommend our guide: Football Field Valuation.
The most straightforward way to value a private company is to look at the assets the business has. Here, we will look at two approaches to valuing a business based on its assets. Later on, we will look at different types of assets and how to assign value to them. This section serves to overview how these two methods work.
The first method assumes we have good financial information, and we basically trust that it’s accurate enough to use. This method is better suited for valuing a business doing more than $10 million in revenue.
This would give you a valuation of the business’ assets. You could use this in a football field chart if you were trying to come up with a price range that might make sense to pay for a business and you just wanted an asset valuation to throw in there for perspective. However, if you were considering breaking up or liquidating the company, we will address some issues with this valuation method below.
Second, we will look at a more granular way to value a business’ assets. This method would make more sense if we’re looking at a smaller business, or we intend to use this valuation to do some digging to try and determine exactly what someone would pay us for individual assets.
This would also give us a valuation of the business’ assets, using a different approach to calculating that value. This method doesn’t distinguish between tangible and intangible assets, because this method would normally be used to take into account only assets we were considering selling. The assets in question here could be tangible like real estate or vehicles, or intangible like patents.
The first method is more accurate at telling us what those assets are worth from an accounting standpoint. Accounting standards leave room for interpretation and we need to trust the data in order to use this method. The second method is better suited for singling out key assets so that we can do some digging and see what those assets could be realistically sold for. As an example, we could call brokers, dealers, or middlemen and get price quotes on specific assets this way and we could use those quotes or estimates for our valuation of what those assets could realistically be sold for tomorrow. This method is also preferable when buying a small business that doesn’t have a lot of assets as it is likely a cleaner approach. So, the first method is best for determining the current accounting value of the assets, and in many cases, the second approach is better for determining what individual assets could be sold for tomorrow.
Assuming the business is relatively healthy, generally, the asset valuation method will give you the lowest value for the business out of the four valuation methods we listed earlier.
The asset valuation method doesn’t take cashflow into consideration. It’s a valuation method based on the assets themselves and what they are valued at—taking into account the remaining debt obligations that have to be paid before a return on investment could be realized from the sale of those assets.
Since this valuation method produces the lowest valuation for a business and doesn’t take cashflow into consideration, why would we even want to use it?
Previously, we mentioned that there were four main methods for valuing private companies: the discounted cashflow method, comparable company analysis, precedent transactions, and the asset valuation method.
Here are some instances where the asset valuation method is extremely helpful for valuing private companies.
First, this method is useful for valuing new companies that don’t have a financial track record. Newer businesses that haven’t been around long enough to prove a tack record (or even generate sales) can’t be valued based on their revenue or cashflow—but they are worth something.
It takes some businesses years to generate positive cash flows (or even any revenue at all), but some of them own lots of assets or own high-value assets. Some examples of these assets could include real estate, vehicles, machinery, inventory, etc. The asset valuation method is useful in circumstances where the company can’t be reliably valued based on cashflow, but it owns substantial assets.
Second, the asset valuation method is useful for private company valuation when we’re trying to take into account how a liquidation would play out. It’s valuable to understand the breakup value for a business, even if you don’t intend to break it up or liquidate it immediately.
In some cases, such as buying a competitor, the intention from the start is to eliminate them. Here, the decision to buy is more heavily dependent on the market share the buyer will gain as a result of less competition, the ability to push price points, access to new customer lists, etc. The remaining assets are to be sold off and the competitor shut down. To learn more about the rationale behind buying a competitor, we recommend our guide: Horizontal Integration.
More traditionally, the asset valuation method is useful for companies that are insolvent, or about to become insolvent.
Third, the asset valuation method is useful for the sale of very small businesses. For an example, we can look at a small food truck business. The business may be run entirely by a husband and wife, that own one truck and have a list of regular local events they cater to. If the owners operate the business daily, and have no employees, then the buyer for the business will be another person that wants to run a food truck.
So, what is the new owner actually buying? Most likely the sale price is based almost entirely on the value of the truck and the sale of this business may be structured as the sale of just a few assets.
In summary, the asset valuation method normally produces the lowest valuation for a business and is useful in helping to understand the breakup or value of a business. This method would give a buyer an idea of what a business is worth at a bare minimum. It’s also useful to use the asset valuation method when we’re trying to value newer unestablished businesses, businesses we plan to break up or liquidate after acquiring, insolvent businesses, and for the sale of very small businesses where the owner/operators are basically selling assets to new owner/operators.
This valuation method is normally not relied on as the primary valuation method for healthy companies, but should be included in a football field chart for comparison purposes.
Previously, we looked at how to value a private company with the asset valuation method:
At first, glance it’s fairly easy to make a list of key assets a company has, to total up liabilities, and to subtract the total liabilities from the value of the assets.
The challenge here is in determining what the business' assets are realistically worth.
If an acquirer were to use the asset valuation method to help them make a decision about buying a business, they would need to be accurate in what those assets are worth—not just on paper, but what those assets are worth to them.
Assets are normally categorized as either tangible or intangible. Tangible assets are physical assets, like real estate or vehicles. Tangible assets include both fixed assets, like real estate and machinery and current assets, like cash or accounts receivable.
Alternatively, we have intangible assets, which are not physical in nature—such as trademarks, patents, and goodwill. It is often much easier to value physical assets than intangible assets. There is a great deal of subjectivity that goes into valuing intangible assets. It’s often justified by what the buyer thinks they can achieve through making the deal.
From an accounting standpoint, here are some common ways that assets are valued:
We’ve also discussed an alternative approach to this. If we are able to see a list of key assets, we can call around and get price quotes and estimates of what someone would pay for an asset today. As we can see, this is a much different way of valuing an asset than historical cost, market value, or standard costs.
This would normally produce a lower valuation of the assets, but would be much more helpful if we were looking for perspective about the liquidation value of the business.
We will look at the distinctions between what someone is offering to pay and accounting value next.
This section will overview some of the challenges with the asset valuation method.
Just because these assets have value on paper doesn’t mean you can sell them for that amount.
When considering the asset valuation method with the intention of selling assets, it’s beneficial to think through whether or not the assets in question can realistically be sold. If they can, who would buy them?
It’s also worth thinking through whether or not they would need to be further discounted (from their value today) to sell them in a reasonable timeframe. As an example, we’ll look at a business that paid $400,000 for ten delivery vans a few years ago. Today, the market value of those vans (based on market data) is $300,000.
Who would they try and sell those vans to? What they are worth and what someone will pay us for them relatively quickly are different things. Middlemen often make money through arbitrage. This means that they know they can find a buyer for the vans at their market value (that’s their business), and they plan to take their profit by purchasing them at a discount. Say we found a dealer that specializes in used commercial vehicles and they offered to pay us $200,000 for the vans. They know they are worth $300,000, but they also know they can’t sell them for $400,000. So the difference comes out of the seller’s pocket if they go through channels like this.
In addition to arbitrage, brokers and intermediaries often make money through commissions and fees. If they are not being paid one way, they are being paid another. Some may try and make money with all three at once.
If you were using the asset valuation method for a private company intent on selling off assets, it is certainly in your best interest to try and remove as much of the guesswork as possible.
