by J L Petriesan

Created on: January 30, 2008

What's your company worth?

Depends on who is trying to assess a value. A potential buyer? You as a seller? You as an operator/owner? You ex-spouse in a property settlement case? You in a property settlement case with your ex-spouse?

The general rule, which is the old IRS Revenue Ruling 59-60, says that the fair market value of a company is that price at which the company would change hands between a willing buyer and seller, both having access to all relevant factors. Simple enough, right? Yeah. I have in my office a stack of books explaining how to apply this standard.

In the most basic sense, any business asset is worth what it will produce in the future. Determine what that is, and, using an appropriate discount factor, discount to today. This is simple enough, but does involve forecasting cash flow into the future and then subtracting out something for the time value of money.

For simplicity, let's agree that your business throws off $100,000 per year now to you and that net cash to you is expected to increase by 4% per year forever. And that you are willing to do the work necessary to maintain that business. Using the "rule of 72" (72 divided by the interest rate tells you roughly how long it will take to double your investment), in 18 years, it will be throwing off about $200,000; in 36 years, probably when you are ready to call it quits, it will be throwing off about $400,000. But with inflation at 3% per year (the long term average), the $400,000 in 36 years is worth about $138,000 in today's dollars; or 38% better than today.

The basic formula is PV = FV/((1+i)^n); where PV is the Present Value, FV is the amount in the future, i is the assumed interest rate, and n is the number of periods involved. The inverse is FV = PV X (1+i)^n; ($138,00 invested at 3% for 36 years well yield $400,000.
Ok, so for this example, your business will generate $100,000 in year 1, $104,000 in year 2, $108,160 in year 3 ($110,000 times 1.04); $112,486 in year 4 ($108,160 times 1.04) and so on for 36 years.

We are half way there. Now, what is the correct way of evaluating what that cash flow stream, which, over 36 years, amounts to a total of $7.75 million, is worth today in other words, what would someone be willing to pay for that?

If you assume that government securities are safe (which is what most valuation experts do) and that they are paying 6%, the formula is to see how much in government securities one take today in exchange for the future collection of $7.75 million. By

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