Publication: Balance Sheet April 2021
Enterprise or business valuation involves a series of steps that are implemented in the course of business transactions. Natalia Sniega, Senior Financial Analyst at Auctus Capital, explains what these transactions are and how crucial a business valuation can be in each case.
The need for a business valuation can arise in a number of situations - when considering whether to buy or sell a company, when planning to attract an investor, and for strategic planning to better navigate the market and make better plans for the future.
There are situations where a business valuation is a necessary step. One of these is business transaction planning - deciding whether to sell, buy or merge a business, or whether to attract an investor. A valuation will be necessary to correctly determine the desired price range for the transaction. Valuation will also help to avoid a situation where an investor is interested and ready for a deal, but the deal does not materialise due to unreasonable expectations of the value of the business by the existing owners, or the parties fail to make a sufficient case for the proposed transaction price. Given that selling a company and attracting investors tends to be a time-consuming process, it may be necessary to revise the value of the company after a certain period of time, usually influenced by the ability of the company to deliver results within the set budget and management plans.
Business valuation can also be a formality when it comes to strategic planning. Depending on the future objectives of the business owners, an indicative, rough valuation may also be sufficient here.
In Auctus Capital's practice, there have been various cases where a valuation has been a necessity. For example, a valuation was carried out in the interests of minority shareholders. In a situation where a majority shareholder offers to buy out the minority shareholder's shares in a company, the parties tend to have different views on the value of those shares. An independent valuation helped the minority shareholder to argue its view on the price of the shares and to obtain more favourable transaction terms for itself.
Quite often, we have seen a situation where one of the two owners of a company is interested in selling his shares and the other is not interested in buying them back. For people with no experience in buying and selling companies, this situation sometimes seems too difficult to resolve. In this case, it is useful to call in consultants who will carry out a valuation of the shares and help find a buyer for the shares, structure the transaction and find the necessary financing to complete the deal. There have been cases where the involvement of a consultant has led one of the owners to change his mind and buy the shares from his former partner.
There are different methods to value a business.
In determining the value, several methods are usually used, with a weighted average subsequently determined in order to obtain the most objective result and to balance the disadvantages of each method. The most commonly used valuation methods are:
Income method. This method takes into account both the historical performance of the company and future projections, converting them into today's value. The key factor is the company's own performance and its ability to achieve the forecast. The discounted cash flow method uses future cash flows based on carefully constructed forecasts, discounted to determine their value today. Here, the value of the company will be influenced by growth plans, the current and expected capital structure, the level of investment required to operate the business. This method usually assumes that the company will continue to operate and grow in the future, but it can also be applied in the opposite case.
Comparative method. This method, unlike the previous one, focuses more on the actual situation of the company. Here, the market situation has a decisive influence on the value of the company; future projections are not taken into account. The valuation is based on a comparison of transactions that have taken place on the market, assessing what investors were willing to pay for similar companies. Industry average ratios can be applied to a company's financial ratios - turnover, earnings before interest and tax, EBITDA. The result is adjusted for the size and structure of the company's liabilities. When applying the benchmarking method in the Baltic market, it is important to select and find the most appropriate examples for comparison. For example, it will not be objective to compare a local medium-sized company with companies publicly listed on European stock exchanges.
Cost method. The value of a business is determined by the investment required to recreate a similar business with its entire asset base.
In buy-sell or merger transactions, as well as in investor financing, a due-diligence process is carried out to clarify the value of the business and therefore the transaction price. This is usually carried out once the parties to the transaction have agreed indicatively on the terms of the transaction and the investor or buyer has an initial view of the target company. The due-diligence process allows the investor to verify that the factual situation corresponds to the information obtained in the negotiations. Such due diligence is usually a prerequisite for closing a transaction and can have a significant impact on the terms of the transaction. For example, if this process reveals any financial risks that may affect the company's performance after the closing of the transaction, the investor will carefully assess the options and costs involved in addressing them. The potential costs of not addressing the risks are also assessed and factored into the price.
In addition to the valuer's knowledge and understanding of valuation standards and best practices, actual experience in structuring, managing and executing buy-sell transactions is also important in determining the value of a business. Only by being involved in the actual transaction processes is it possible to assess all the nuances and market-specific conditions that may affect the value of a business.
Auctus Capital's team of professionals will determine the value of the company and, at the client's request, provide further assistance in the process of the desired transaction.
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