Business valuation

[Andrew]

OK another business topic as I enjoy these. I know the answers vary and always depend on the situation but I'll ask anyways.

When valuing a business what do you look for/use to value it? Obviously the present value of what your future cash flow will be. Then there is the debt/equity ratio and how that picture looks. What else? Is there one that out weights another?

The reason I ask this is I often don't understand how these companies in the bay area get $500k - $1 million in funding with a piece of paper and idea. I know some of it is based on the horse (i.e. the entrepreneur has a proven record) at the same time I often see the opposite.

[Lil Squid]

I think there are two different things involved here. Going concern value of an existing business vs. financing a new business based on a business plan. Value of an existing business is a sum of its assets (realty, working capital, accounts receivable, raw materials, inventory, work in progress, intangibles including intellectual property, goodwill, contracts, etc.) minus its liabilities (accounts payable & other operating costs, bank debt, contract disputes, etc.) - i.e. book value; however, to evaluate the attractiveness of a business, you will want to calculate its net present value based on future income.

How a business would go about getting a loan or investment would depend on whether it is an established company or a new venture, and whether the money are intended as a secured or unsecured loan (debt) or as equity in the company (in exchange for a piece of ownership). Secured loans are easier to get: if a business has sufficient assets, it can pledge those against the loan (including accounts receivable and other payment streams and inventory).

Unsecured loans and equity investments usually require that the business puts together a thorough business plan that outlines everything from sourcing raw materials to production to distribution and sales, including studies of target customer base, location, comparable businesses in the area, historical data and much much more.

And yes - this very much depends on circumstances.