Well, as simple as buying a three storey home, sight unseen, in a highly unsavoury neighbourhood, that has been owned by a serial killer who dresses as a clown..
So, what’s it take to get an accurate and realistic valuation of your business?
Well, there are many trains of thought on valuations, which very much depend on the purpose for which you want the valuation. If we put aside valuations by business appraisers for the following:
- disputes related to estate
- for raising capital investment
- gift taxation
- divorce litigation
- estimating the value of partners' ownership interest
- ascertaining business assets for a variety of legal purposes
Publicly traded companies on major stock markets have an easily calculated "market capitalization", which is a direct estimate of the market value of the firm's equity. All you need to do is find the company’s stock price (the price of a single share) and multiply it by the number of shares outstanding; you then have the equity market value of the company.
Then, there are the valuations used by investors when making strategic investment decisions, concerning entering new sectors or making fund calculations and forecasts. Such estimates need some rationale and a basis for calculation and need to be possible within a reasonably short timeframe.
Many Calculation Methods Used
For such calculations, there is a long list of financial models that can be used, the most common of which, are the following:
- Discounted Cashflow (DCF)
- Multiple of Discretionary Earnings Method
- Asset Accumulation Method or Assets/Based Method
- Multiples Method / Market Valuation
- Comparable Transactions Analysis
- Averaged Multiple Methods
What Does it Mean for A Trade Sale?
As a specialist M&A broker, what I am more concerned about and focussed upon is the valuation of a business that is intended for trade sale. The estimated valuation is used by the shareholders and owners at the beginning of an M&A process to set some level of expectation on the final sale value. It is also used by the buyers to gain authorisation to proceed on an acquisition and for negotiation purposes.
As I have stated in previous blog posts, if you want to value your house, then you usually have many direct or very close comparisons on which to base your valuation. Variations in houses can be taken into consideration when calculating the value, with a high degree of accuracy - These would include location, number of bedrooms, land associated with the house etc. However, a business can contain many levels of value, risk and potential that can create a much more complicated calculation. An important aspect to consider is the market conditions and current drivers. For example, when a sector or sub-sector/ technology is ‘hot’ then, for many it may be faster and more cost-efficient to acquire rather than develop - and this calculation can add another very important aspect to the final valuation paid.
The reality is that there is no simple way to establish an accurate sale price for a business because it always boils down to what somebody is prepared to pay. The knowledge behind this calculation is not to be found in classrooms or books as it is more art than science; however, with a liberal sprinkling of experience and some specific industry knowledge added to the mix, a ‘recipe’ for this calculation can be created and a realistic valuation achieved.