Introduction to Business Valuation: Principles and Approaches

Introduction: What is a Business Worth?

“Price is what you pay. Value is what you get.” – Warren Buffett

Valuation is both science and art. It’s the process of estimating what a business is worth—but “worth” depends on perspective, purpose, and methodology.

Whether you’re an investor evaluating a stock, a buyer negotiating an acquisition, or a founder raising capital, understanding valuation is fundamental to making good financial decisions.

Why Valuation Matters

Uses of Business Valuation

1. Investment Decisions

• Buy/sell stocks
• Compare investment opportunities
• Assess fair value vs market price

2. Mergers and Acquisitions

• Buyer determining offer price
• Seller setting expectations
• Negotiation basis

3. Fundraising

• Setting valuation for equity rounds
• Pricing IPOs
• Negotiating with investors

4. Legal and Tax Purposes

• Estate planning
• Gift taxes
• Shareholder disputes
• Divorce settlements

5. Internal Management

• Performance measurement
• Value-based management
• Capital allocation

Fundamental Concepts

Intrinsic Value vs Market Value

Intrinsic Value:

• “True” value based on fundamentals
• Derived from future cash flows
• Independent of market sentiment
• What the business is “actually” worth

Market Value:

• What the market will pay
• Reflected in stock price (for public companies)
• Influenced by supply, demand, sentiment
• May differ from intrinsic value

Investment Implication:

• If Intrinsic Value > Market Price → Undervalued → Buy
• If Intrinsic Value < Market Price → Overvalued → Sell

Enterprise Value vs Equity Value

Enterprise Value (EV): Value of entire business operations

$$EV = Market\ Cap + Total\ Debt - Cash$$

Equity Value: Value attributable to shareholders

$$Equity\ Value = EV - Net\ Debt$$

Or directly: $$Equity\ Value = Share\ Price \times Shares\ Outstanding$$

Going Concern vs Liquidation

Going Concern: Assumes business continues operating indefinitely. Value = PV of future cash flows

Liquidation: Assumes business is shut down and assets sold. Value = Net proceeds from asset sale

Usually: Going concern value > Liquidation value (Otherwise, company should be liquidated)

The Three Valuation Approaches

1. Income Approach

Principle: Value based on expected future economic benefits

Primary Method: Discounted Cash Flow (DCF)

Logic: $$Value = \sum_{t=1}^{∞} \frac{Expected\ Cash\ Flow_t}{(1 + r)^t}$$

When Most Useful:

• Mature businesses with predictable cash flows
• Long investment horizons
• When fundamentals matter more than comparables

Key Inputs:

• Projected cash flows
• Discount rate (WACC)
• Terminal value assumptions

2. Market Approach

Principle: Value based on what similar assets trade for

Primary Methods:

• Comparable Company Analysis (trading multiples)
• Precedent Transactions (deal multiples)

Logic: $$Value = Metric \times Multiple$$

When Most Useful:

• When good comparables exist
• For relative valuation
• Market-oriented transactions

Key Inputs:

• Selection of comparable companies/transactions
• Appropriate multiples
• Adjustments for differences

3. Asset Approach

Principle: Value based on underlying assets

Primary Methods:

• Book value
• Adjusted book value
• Liquidation value

Logic: $$Value = Assets - Liabilities$$

When Most Useful:

• Asset-intensive businesses
• Holding companies
• Distressed situations
• Real estate companies

Key Inputs:

• Asset values (market vs book)
• Liability assessment
• Intangible asset treatment

Choosing the Right Approach

Decision Framework

Multiple Methods = Better Answer

Best Practice: Use multiple approaches and triangulate

Why?

• Each method has limitations
• Range is more realistic than point estimate
• Different methods may be appropriate for different components
• Increases confidence in final value

Key Valuation Metrics and Multiples

Enterprise Value Multiples

EV/EBITDA

• Most common in M&A
• Capital structure neutral
• Ignores depreciation (good for comparing different accounting)

EV/EBIT

• Includes depreciation impact
• Better when depreciation represents real cost

EV/Revenue (EV/Sales)

• For unprofitable companies
• High-growth companies
• SaaS/tech businesses

Equity Multiples

P/E (Price/Earnings)

• Most widely quoted
• Affected by capital structure
• Easy to understand

P/B (Price/Book)

• Asset-heavy industries
• Banks, insurance, real estate
• Value investing focus

P/S (Price/Sales)

• Unprofitable companies
• Early-stage companies

Why Enterprise Multiples?

For comparing companies with different capital structures:

• Company A: No debt, P/E = 15x
• Company B: High debt, P/E = 10x (earnings boosted by leverage)

Solution: Compare EV/EBITDA instead—normalizes for capital structure

Valuation in Indian Context

Challenges

1. Limited Comparables

• Fewer listed companies in some sectors
• Diverse business models even within sector
• Size variations significant

2. Promoter Control Premium

• Many companies promoter-controlled
• Control has value
• Minority discounts may apply

3. Related Party Complexity

• Inter-company transactions
• Need to normalize earnings

4. Market Volatility

• Indian markets can be volatile
• Market multiples swing widely
• Timing matters

Typical Valuation Ranges by Sector

Note: Ranges are indicative and vary with market conditions

Common Valuation Mistakes

Mistake 1: Inconsistent Assumptions

Problem: Growth rate doesn’t match capital needs Example: Projecting 30% growth but flat capex

Solution: Build integrated financial model

Mistake 2: Terminal Value Dominance

Problem: Terminal value is 80%+ of DCF Question: Is your explicit forecast period meaningful?

Solution: Extend forecast period, stress-test terminal assumptions

Mistake 3: Wrong Comparable Selection

Problem: Comparing apples to oranges Example: Comparing TCS (mature) to small-cap tech startup

Solution: Carefully select and adjust comparables

Mistake 4: Ignoring Control Premium

Problem: Using minority trading multiples for control acquisition Solution: Add control premium for acquisitions (20-40%)

Mistake 5: Point Estimate Fixation

Problem: Believing valuation is a single number Reality: Valuation is a range

Solution: Present range, sensitivity analysis

Mistake 6: Over-Relying on One Method

Problem: Using only DCF or only multiples Solution: Triangulate with multiple approaches

The Art of Valuation

Judgment Matters

Two analysts, same data, different values—Why?

• Different growth assumptions
• Different risk assessments
• Different comparable selections
• Different terminal value approaches

Context Matters

Value depends on:

• Purpose (investment, M&A, litigation)
• Buyer (strategic vs financial)
• Market conditions
• Negotiating position

What Valuation Cannot Do

• Predict the future with certainty
• Remove subjectivity entirely
• Guarantee a transaction price
• Replace commercial judgment

Professional Valuation Standards

In India

Registered Valuers Under Companies Act:

• Asset class: Securities or Financial Assets
• Registered with IBBI (Insolvency and Bankruptcy Board)
• Follow IBBI (Valuation) Regulations

Valuation Reports Required For:

• Preferential allotment
• Schemes of arrangement
• Related party transactions
• Insolvency resolution

International Standards

• International Valuation Standards (IVS): Global standards
• ASA (American Society of Appraisers): US standards
• CFA Institute: Best practices for investment analysts

Building Valuation Skills

Foundation Skills

1. Financial Statement Analysis

   • Read and interpret financials
   • Identify quality of earnings
   • Normalize for comparisons

2. Financial Modeling

   • Build integrated models
   • Forecast cash flows
   • Sensitivity analysis

3. Industry Knowledge

   • Understand business models
   • Know value drivers
   • Recognize comparables

Advanced Skills

4. Judgment and Experience

   • Pattern recognition
   • Knowing what matters
   • Avoiding biases

5. Communication

   • Explaining assumptions
   • Presenting ranges
   • Defending conclusions

Key Takeaways

1. Three approaches: Income, Market, Asset—use multiple
2. Enterprise vs Equity value: Know the difference
3. Context matters: Purpose, buyer type, market conditions
4. Range, not point: Valuation is inherently uncertain
5. Indian nuances: Promoter control, limited comparables, volatility
6. Triangulate: Multiple methods increase confidence
7. Art and science: Numbers meet judgment

Disclaimer

This article is for educational purposes only. Business valuation requires professional expertise. Consult qualified valuers for specific valuations. This is not investment advice.

Frequently Asked Questions

Q: Which valuation method is best? A: Depends on the situation. DCF for stable businesses, multiples when good comparables exist, asset-based for asset-heavy companies. Best practice is using multiple methods.

Q: How accurate is business valuation? A: Valuation is an estimate, not a precise science. A good valuation provides a reasonable range. Accuracy improves with better data and judgment.

Q: What’s a good EV/EBITDA multiple? A: Varies by industry, growth, risk, and market conditions. No universal “good” multiple. Compare to similar companies and historical ranges.

Q: Do I need a professional valuer? A: For formal purposes (legal, regulatory, M&A), yes. For investment analysis, you can do it yourself with proper training.

Q: Why do different analysts give different valuations? A: Different assumptions about growth, risk, and terminal value. Also different methodologies and judgment calls.

Valuation is the language of finance—the way we express what things are worth. Like any language, fluency comes with practice. The more valuations you do, the better you understand which methods work when, what assumptions matter, and how to exercise judgment. Master valuation, and you unlock the ability to assess any investment opportunity.