Blog - Business valuations; is it rocket science?
Wednesday, 03 May 2017
There’s little doubt that valuing a business takes considerable experience and expertise to form a credible, reliable and defendable valuation opinion. At the same time, there is a fundamental need to understand the business and apply general common sense and logic. So, is it rocket science?
There isn’t a ‘one size fits all’ approach to a business valuation. Different valuation methods are suitable for different businesses dependent upon the industry sector, the first and second tier management structure, the purpose of the valuation and what would be seen as the industry norm. Valuers may even use a combination of methods to reach their conclusion.
For a profitable trading Small & Medium Enterprise (SME) it’s quite likely that the most appropriate valuation method will be to apply a multiple to its profits (the earnings method).
Firstly we need to establish the profitability. The most common and understood route is EBITDA (Earnings before interest, tax, depreciation and amortisation). A valuer will assess what additional adjustments need to be made to demonstrate a synergy saving position for a prospective purchaser. This results in an ‘Adjusted EBITDA’.
The next step is to apply a multiple against the ‘Adjusted EBITDA’. It is at this point that a valuer pulls on their experience and solid research into an industry to find comparable multiples. The more niche a business is the harder this process will be, purely from the lack of transaction activity on the market.
There are, as you might expect, many finer intricacies to this process, but valuations should never appear to be as complicated as rocket science. If they do then they have failed, because valuations should always be underpinned by common sense, logic and clarity.
Valuations in practice
Simply put, a business is worth as much as somebody is prepared to pay for it and what a vendor is willing to accept. A business that is subject to a number of bids is likely to achieve a higher price, as the price can be increased due to ‘competitive tension’.
There are other factors to consider when looking at valuations in the context of a transaction. While the overall price is going to be an important factor, almost equally important is how and when that price will be paid? In addition, there are tax considerations with any deal. An offer for the company trade and assets might prove to be a higher tax bill when compared to an offer for the shares when calculating the net proceeds pocketed by the vendor.
In summary, there is a lot to consider when valuing an independently owned company that requires specialist advice.
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