Valuation Methods

Valuation Methods: An Overview

Choosing the right valuation method is a crucial factor for a well-founded business valuation. Whether in the context of a sale, succession, or merger, accurately determining the company’s value forms the basis for strategic decisions. Valuation methods serve to objectively determine the economic value of a company, with different approaches applied depending on the type of company, industry, and objectives.

The most important valuation methods include the DCF method (Discounted Cash Flow), the multiplier method, and the asset-based valuation method. Each of these methods has its strengths and weaknesses as well as specific areas of application. While the DCF method is based on future cash flows, multipliers consider industry-standard key figures, and the asset-based method focuses on a company’s assets. The following sections provide a detailed examination of these approaches.

DCF Method: Future-Oriented Valuation

Determining Free Cash Flow

The DCF method (Discounted Cash Flow) is one of the most commonly used methods for business valuation. Its focus lies on determining a company’s future economic potential. The starting point is the free cash flow, which represents the funds available to a company after deducting all operating and investment expenses. This is calculated based on financial forecasts over several years.

For example: A manufacturing company forecasts increasing revenues over the next five years due to the launch of a new product. Using the DCF method, these expected cash flows can be calculated and then discounted to determine the company’s present value. However, these forecasts require a thorough analysis of market conditions and corporate strategy.

Capitalization Rate and WACC

A central component of the DCF method is the capitalization rate, often referred to as the Weighted Average Cost of Capital (WACC). The WACC reflects the company’s average cost of capital and takes into account both equity and debt financing. A higher WACC indicates greater risk, which reduces the discounted value of future cash flows.

Accurately calculating the WACC requires a detailed analysis of the capital structure. For example: A technology-oriented company with a high equity ratio may have a lower WACC than a heavily debt-financed manufacturing company. This directly affects the determined company value and makes the DCF method a highly nuanced valuation approach.

Multiplier Method: Simple and Practical

EBITDA Multiples

The multiplier method is based on the assumption that companies within an industry exhibit comparable valuation metrics. One of the most common metrics is the EBITDA multiple, which relates the company value to earnings before interest, taxes, depreciation, and amortization. This method is particularly widespread in industries with established valuation benchmarks.

For example: A mid-sized service provider with an EBITDA of €1.5 million could be valued using an industry-standard multiple of 6, resulting in a company value of €9 million. This method is quick and easy to apply but does not account for individual company specifics.

Revenue Multiples (e.g., for SaaS Companies)

For technology-oriented companies, especially in the Software-as-a-Service (SaaS) sector, revenue multiples are a frequently used valuation basis. This method considers the growth potential and scalability of such companies. A SaaS company with annual revenues of €5 million could, for instance, be valued using a multiple of 8, resulting in a company value of €40 million.

While this method is practical, it carries risks as it does not incorporate cost structure or future profitability. Nevertheless, it remains a popular tool for valuation in fast-growing markets.

Asset-Based Valuation Method: Asset-Focused Valuation

Valuation of Fixed Assets

The asset-based valuation method focuses on assessing a company’s tangible and intangible assets. It is particularly suitable for companies with a high proportion of physical assets, such as production facilities or real estate. This method calculates the value of fixed assets based on current market prices or replacement costs.

For example: A manufacturing company with a machinery portfolio estimated to have a market value of €5 million uses the asset-based valuation method to determine the contribution of fixed assets to the overall company value. This method provides a solid foundation for valuation but does not consider future earning potential.

Valuation of Intangible Assets (Patents, Trademarks)

Intangible assets such as patents, trademarks, or software licenses play a critical role in many companies. Their valuation is complex, as it heavily depends on market conditions and future revenue potential. Approaches such as the license price analogy or market price comparison can be used to determine an appropriate value.

For example: A technology company values its patent portfolio based on the licensing fees it could generate from potential users. This approach reflects the future value of intangible assets and complements the asset-based valuation method with a dynamic perspective.

By combining these methods, companies and investors can gain a comprehensive understanding of the true value of a business.