The Train Trip
On a recent train trip I got talking with a fellow passenger.
After the usual introduction, her name was Conchita, she asked me: “I would like to sell my current business and then buy a new one, that is better suited to my interests. But how do I value my business?”
“ Well” I responded,” good question indeed. The answer torments business sellers and buyers for some time. There isn’t one precise method that establishes a valuation beyond argument.”
“Conchita, “ I said “the value of a company can vary greatly. Depending on the respective viewpoint of the parties involved.”
Conchita kept persisting: “ok, understood, but how easy (or complicated) is it to estimate the true value of a business?”
Company Valuation Reasons
A company valuation can have different purposes. The most common one are:
- purchase and sale of a company due to retirement or health reasons
- attracting new investors, eg for expansion
- takeover or merger
- adding or changing shareholders
- compulsory part calculations in inheritance division
The company valuation serves as a basis for decision-making for both:
- the Seller (which maximum amount can I demand?)
- the Purchaser (which minimum amount should I offer?)
In my experience, Seller and Purchaser are generally colliding with their respective views between the value of a company and its (selling) price.
- As with every commodity, the price is determined supply and demand.
- A starting point for negotiating the sale or the takeover price.
- Both parties should (ideally target) a company value that is as realistic as possible.
Many Valuation Methods
There are many valuation methods. Most can lead to different results. There is no binding method.
I said to Conchita: “Choose the method that best suits the size of the company. Your capital and asset structure as well as your specific industry. Then test the result with at least two methods.”
Typically, Seller and Purchaser regard the financial side from different angles.
- often emotionally connected to their company and
- most of the time their evaluation is based on the past.
- approach the valuation more rationally and
- are interested in the growth potential
- ultimately, they want to pay as little as possible.
It is not uncommon for the seller, and also their consultant or accountant, not to know how to determine a realistic price for the company.
In the case of an overvaluation, there is a risk that the seller party will ‘overplay its hand’. The search for potential purchasers interest or indeed the subsequent negotiations could be at risk or fail completely.
Non-operating factors influence pricing
Although the company value is ideally determined according to objective criteria, other factors are often decisive for price determination. These can be:
- Personal influence of the current owner in his/her company
- Anticipated (but not realized) sales and profit development
- Degree of innovation of products or services (niche)
- Size of the company and competence of the internal organization
- Strength or presence of Competition
- Number of takeover offers and purchasing candidates
- Age of successor
- Financial and family situation of both parties
More than just A Selling Price (just like the song ‘It’s more than a feeling?’)
I said to Conchita: “Involve your banking partner in the valuation.
The value of your company is also a reflection of the company’s creditworthiness.
Which in turn leads to favorable credit rating and favorable credit conditions such as interest rates.”
Several methods are available for determining the company value. For simplification I am just listing the following:
Is the most commonly used valuation method. It determines the Net Assets= Owners Equity.
- Relative easy to carry out
- Based on current data that can be accessed easily
- Purely based on current information
- Disregards external factors, eg economic environment
- Does not take into account future growth (potential)
Discounted Cash Flow Analysis (DCF)
The DCF analysis is one the most thorough method to value a company.
This method is used to calculate the value of a company from the discounting of future cash flows.
- High degree of recognition internationally
- Used by most financial practitioners
- Based on future data
- Involves some guesswork of future cash flows
- Requires Excel and Financial Analysis skills
Pimping your Business
I don’t know what you, the reader, would recommend to Conchita.
My final comments, before I disembarked at the Hauptbahnhof: “Conchita, keep in mind that getting a company ready for sale or indeed its valuation is not a straight forward thing.
The price which an investor would be willing to pay for your company’s equity depends on supply and demand. And also a number of Emotional Factors.”
Markus is a Financial Professional, specialising in Process Improvement and Financial Reporting.