While balance sheets and perceptions are both important in the valuation of a company, the success of a sale usually comes down to one thing: price
Valuing a business has been described both as an art and a science. In truth, a great deal depends on perception. However, there are common fundamentals that will feature in most company valuations.
The process begins by establishing the expected underlying profitability of a business at the time of valuation. This is followed by an assessment of the risk profile of the business to determine the appropriate cost of capital or multiple cost of capital to apply.
The valuations of earnings are fundamental to this, and should be before interest, tax, depreciation and amortisation (EBITDA), thus enabling potential buyers to compare similar businesses without taking the individual structure into account.
“A company’s annual accounts are a year-end ‘snapshot’, but they don’t illustrate your business profile during the year,” says Shaz Nawaz, director of AA Accountants. “A cash flow analysis of the past year and a forward projection are much more convincing.”
In theory, a business is worth the present value of expected future cash flows, discounted by an appropriate rate. In practice, the value of a business in the market is based on a mix of quantitative and qualitative factors.
Natalie Tanne, partner and corporate adviser at Merger Partners, explains: “Quantitative factors include historical performance, earnings multiples for similar public companies, recent sales of similar businesses and so on.
“Qualitative factors include management strength, the existence of a moat (protection against competitors, monopoly or high barriers to entry), recurrent income and more.”
Deal structures become more important when there is a gap between the seller and acquirers’ perceptions of the value.
Mechanisms such as earn-outs can be used to bridge the gap by reassuring an acquirer that it won’t pay for value that isn’t delivered, while reassuring a seller that they are not leaving value behind.
“Negotiating these can be tricky because they involve the allocation of risk, and an experienced adviser can make a huge difference here,” says Daniel Domberger, partner at Livingstone Partners.
Ultimately, the market is the arbiter of a company’s worth. To get a proper feel for the value a company will achieve on a sale, conversations need to be initiated with prospective purchasers to gauge the level of interest in the business.
Peter Gray, partner at Cavendish Corporate Finance, says: “Critically, if you can attract interest from one, or preferably multiple, overseas buyers, you may be able to achieve a significant premium to a textbook valuation, because overseas purchasers will frequently be prepared to pay a strategic premium to enter the UK or European market.”
Japanese and Chinese buyers, for example, tend to pay significantly higher prices for UK businesses relative to textbook valuation methodologies.
The competitiveness of the process, the prevailing market conditions, and the strategic need of the buyer will then influence how far beyond this formal or purely financial valuation an acquirer may be willing to stretch.
This is where a good adviser can maximise the likelihood and impact of these factors on the ultimate valuation.
Then there is the value in the “eye of the beholder”. Formal valuation methods aside, it is important to stand back to ask whether a willing buyer and seller would be prepared to transact at that value.
Tomas Freyman, valuations partner of BDO, says: “There is a science behind valuing a business, and valuation techniques such as discounted cash flow and market approach are at the heart of any process.
“However, these methods should always be overlaid with a commercial sense check. An ability to stand back and determine where the true value lies is important; is it in the brand, the customer relationships, technology, know-how or something else?”
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