This article is part of the March 2024 issue of North West Business Insider.
If you are planning to exit your business or acquire a business, it is fundamental to spend the time to prepare a business valuation. A valuation is predicated on various assumptions and will result in a range of values that reflect what an open market valuation would look like. However, the value of a private business is determined by negotiation between a willing buyer and a willing seller, each of whom will be acting for self-interest and gain and will be well informed about the company and the market within which they operate.
Whilst business valuations are important at the time of a transaction, it is also useful to consider business valuations as part of your business's strategic plan. This enables you to focus your efforts on the key value drivers at present and for the future, to achieve your goals.
We are experienced in all aspects of valuing a business for a multitude of reasons, such as:
- strategic reviews
- exit planning
- acquisition target valuations
- raising capital or equity
- corporate restructuring
- share issues and employee incentive schemes
- forensic investigations.
Valuation methodologies and techniques are wide ranging and depend heavily on the type of entity, the market sector, and the financial performance of the business.
As a snapshot, we focus on some of the common approaches to business valuations and highlight certain pros and cons of using each basis:
Price/earnings basis
Using a private company valuation as an example, the price/earnings basis involves identifying the relevant earnings and applying a relevant multiple, known as the price/earnings ratio. This ratio can be derived from comparable transactions or a listed company in the same industry, adjusted to reflect the private company's lower marketability. Underlying business earnings are typically adjusted for exceptional and non-recurring items, which can be subjective.
Pros
This works well for trading businesses that can prove consistent profitability, market multiples can enhance values depending on the industry and size of the business, and can be forward looking.
Cons
It can be subjective, and there is a lack of accurate information on private company multiples.
Discounted Cash Flow (“DCF”) basis
The DCF basis looks at the forecast future cashflows of the business and discounts the cashflows to a present value. The calculations are usually very detailed and are heavily reliant on detailed management information and forecasting capabilities of the target and the valuer. Various assumptions are used in the model and the forecast period can be for a significant number of years into the future. Private equity and venture capital firms typically adopt the DCF basis to calculate an Internal Rate of Return (“IRR”), and the intrinsic value of a target company.
Pros
Very detailed including relatively complex modelling, can be used to calculate IRR, sensitivities can be overlaid.
Cons
Requires strong historical/forecast data and granularity for assumptions, can be overcomplicated and doesn’t consider comparable companies.
Net asset basis
The net assets of a business are relatively easy to identify from a recent Balance Sheet. Complexities can arise in a valuation when considering specific line items in the Balance Sheet, such as intangible assets or any complex balances or instruments for example. The valuation may include fair value adjustments to restate certain elements of the Balance Sheet.
Pros
A relatively simple methodology, more appropriate for investment/property businesses.
Cons
Often appears as a business closure value, doesn’t consider future earning potential, may not be so relevant to ‘asset-light’ businesses.
Revenue multiple basis
A revenue multiple is used to value businesses with proven recurring revenue. This is particularly prevalent in software businesses and can lead to very different valuations to businesses valued under the net assets of DCF basis.
Pros
Relatively simple to calculate the valuation, likely to lead to a higher valuation.
Cons
Ignores the financial position of the company from a cash perspective, a large valuation may be placed on a significantly loss-making business.
There are multiple other factors to take into account when valuing a business that all need careful consideration. If you embark on a business valuation without taking appropriate advice or engaging an independent valuation specialist, you may not only miss certain points, but you are at risk of undervaluing your business.
The next step
If you feel you would benefit from corporate finance advise and would like to discuss valuing your business, contact Peter Williams on p.williams@uhy-manchester.com.
