Question

Compare and contrast the different valuation methods. Describe all the possible sources of external funding, both formal and informal. Describe three ways in which an investment is exited.

Answer 1

Asset Based approaches

The asset, or cost, approach considers the value of a business to be equivalent to the sum of its parts; or the replacement costs for this business. This is an objective view of a business. It can be effective in quantifying the fair market value of an entity's tangible assets, as it adjusts for the replacement costs of existing, potentially deteriorating, assets.

Income Based approaches

The income approach identifies the fair market value of a business by measuring the current value of projected future cash flows generated by the business in question. It is derived by multiplying cash flow of the company times an appropriate discount rate. In contrast the asset based approaches, which are very objective, the income based approaches require the valuator to make subjective decisions about discount rates or capitalization. Many considerations and variables are measured to account for the specific contribution of primary value drivers in a business that result in influencing cash flow: revenue drivers, expense drivers, capital investment, etc. This method, which comes in several approaches, is useful as it identifies fundamental factors driving the value of a business.

Market Comparison Based approaches

The Market Comparison approach to a business valuation is based upon current conditions amongst active business buyers, recent buy-sell transactions, and other fairly comparable business entities. Financial attributes of these comparable companies and the prices at which they have transferred can server as strong indicators of fair market value of the subject company.

The important aspect of financing is the character of the funding: informal and/or formal. Especially for early entrepreneurs it is typical that the structure of external financing is dominated by informal sources . Also, two main sources of informal financing are often distinguished: investments, provided by the founders themselves, their family and friends (in other words, “love money” or 3Fs – family, friends and fools); and funding provided by business angels – investors that invest money in an enterprise not because of family relations with its founders.Formal financial sources are divided into institutional venture capital financing,bank loans, initial public offering (IPO), etc. This financial support can be provided in much greater amounts, but requirements for disclosure of accounting data are stricter.In this paper financial sources are analyzed in terms of informal and formal external funding, however, their attraction, from the viewpoint of internal and external financing, is also investigated.