-by Lemuel J. Lim, LL.B.(Hons)(UK), LL.M. (UK), LL.M Tax (US).
How do you use the asset method to value a small business? This article gives a simple explanation. If you are unsure whether the asset method is right for you, see the first article in our firm’s series on How to Value a Business for Purchase or Sale.
An asset valuation is a simple concept. The underlying principle is that the buyer should pay no more for the target business than she would pay to obtain similar assets in the open market. It is an approach to valuation that should always be considered to see if it is applicable. In reality, this method doesn’t get much focus unless (1) the business is a type that relies heavily on fixed assets, or (2) where the business is a highly profitable company where asset valuation is used to try to determine a number that represents the low end of the valuation range.
We will cover here a version of what is called the “asset accumulation” method:
Step 1: Add-up All the Tangible Assets on the Balance Sheet
Start by taking the balance sheet of the business and adding up all the tangible assets less depreciation. Afterwards, make any necessary adjustments to bring each asset in line with what it would cost to obtain comparable assets that are in a similar condition at today’s prices.
For real estate property holdings owned by the business, some people may choose to calculate that using a separate method. Small businesses will typically have access to more expertise to make an alternative assessment of their real estate ownership.
Finally, any subsidiary companies or stock holdings in other companies held by the target business should also be valued in this step.
Step 2: Add-up the Intangible Assets and Any Off-Balance Sheet Assets
Balance sheets are usually prepared in accordance with US GAAP accounting rules. As such, there may be assets that should be identified in the valuation but would not normally appear in the balance sheet. Begin by reviewing the business’s intangible assets before noting down any other assets not accounted for in the balance sheet but that might have value. In particular, look out for any patents, trademarks, trade secrets, customer contracts, copyrights, customer lists, and drilling/natural resource rights.
The business’s employee and independent contractor workforce is also a valuable intangible asset. This can be valued by estimating how much it would cost to search, hire, and put together a recreated workforce with similar experience and expertise.
Valuing intangible and off-balance sheet assets may not be an easy task. You may need to hire expertise to assist you with this.
Step 3: Examine the Liabilities Side of the Balance Sheet
Include all liabilities recorded on the business’s balance sheet.
Step 4: Examine the Off-Balance Sheet Liabilities
Include all liabilities that are not typically recorded on the balance sheet. These would include things like pending legal actions against the business that are currently going through litigation, or the cost of complying with an industry’s regulatory rules.
Many valuations will also take into account liabilities that would be incurred as a result of the sale of the business (if it went ahead). These would include the hypothetical amount of income tax, excise tax, and other taxes that would need to be paid if the sale of the business went ahead.
Step 5: Bring the Assets and Liabilities Together: Total Assets Less the Total Liabilities
The difference between the total value of the assets and the total value of the liabilities is the fair market value of the business.
Post-Calculation Note: Goodwill
“Goodwill” is the actual transaction price the buyer is willing to pay for the business LESS the value calculated using the asset-valuation method (as calculated above). It is considered an intangible asset and represents the value of the “unidentifiable” assets of the business such as the business’s reputation, an exceptionally talented workforce, the loyalty of the customers, etc.
We hope you found this article helpful. Our firm believes in making quality information available online free of charge; and, in that vein, we’ve written on numerous related topics. We encourage you to visit our firm’s business resource page.