276 ENTREPRENEURSHIP
NEW VENTURE VALUATION
What is the new venture worth? How can it be valued? Determining value is a problem
that cannot be avoided even though the methods for calculating it are uncertain and
risky. When a new business is created by purchasing another business or its assets, a val-
uation is required to ensure a fair purchase price and to determine taxes.
A valuation is also needed when a new venture is created and the entrepreneurs need
equity investors. In this case, the valuation tells investors approximately what their
investment might be worth in the future.^26 Investors need this information to calculate
their expected return on investment and bargain for a share (proportion of stock) in the
venture that will bring this return.^27
Because of lack of historical data, the valuation of new ventures and small businesses
is difficult and uncertain. There is no efficient market to determine value since these ven-
tures do not trade their equity on a stock exchange and thus have no market value in this
sense. They have no record of accomplishment either, no indication of potential future
earnings. Unproven companies need to raise equity without being able to show
investors historical returns.^28
Nevertheless, valuations must be made. Three basic approaches to valuation include
asset-based valuations, earnings-based valuations, and the use of discounted cash
flow models.Asset-Based Valuations
Asset-based valuations reveal the investors’ maximum exposure. The purpose of these
valuations is to determine how much the venture would be worth if it were forced to
cease operation and be sold for its tangible and intangible parts. Asset-based valuations
can also be used to determine the cost of assets. There are four types of asset-based val-
uations: book value, liquidation value, adjusted book value, and replacement value.Book Value. The book value of an asset is the historical cost of the asset less accu-
mulated depreciation. An asset originally purchased for $10,000 and depreciated on a
straight-line basis for half its useful life has a book value of $5,000. A fully depreciated
asset has a book value of zero even though it may still be worth something. Because
accelerated depreciation schedules and techniques are employed primarily as tax shields,
during the early life of an asset its book value may understate its economic value.
Frequently, the book value of an asset is simply an artifact of accounting practice and
bears little relationship to its actual economic value.Adjusted Book Value. Sometimes an asset’s book value and its actual economic value
are so at variance that book value must be adjusted to give a better picture of what the
asset is worth. This adjusted book value can be higher or lower, depending on the cir-
cumstances. Upward adjustments are often made to account for land values. Adjusted
book valuations increase the value of real estate, which often rises over time, but—
because of accounting rules—is always left on the books at historical cost. Many busi-
nesses are undervalued on the books because the land they own and control is worth