ICON66 – Volume 5
What Is
Your Business
Worth
Get The Max
– The Art Of
Valuation
If you lined up ten potential purchasers and asked them to value a business you would get ten different answers. Essentially a business is worth a different amount to different people at different times, and the reality is that valuation is a lot more Art than Science.To get a full price you need competition. It’s only when you get purchasers into a competitive environment that you know the real value of your business. Once purchasers are going head to head, fundamentals can get forgotten and in bull markets valuation almost becomes a ‘Dark Art’ as rational measures of value get forgotten in the scramble to do deals. However, in the current climate, buyers have returned to business fundamentals and are firmly focused on profits and assets rather than sales or cash-burn.
There are any number of different valuation techniques purchasers use ranging from discounted cashflow models, asset value, multiple of sales, replacement cost and opportunity cost, but by far the most common valuation method we see for private companies is one of the oldest and most simple, the Price Earnings or PE ratio adjusted for surplus assets:
(Underlying Earnings x Multiple) +/- surplus assets/debt)
Underlying Earnings
Most trade purchasers are looking at acquisitions as a way of improving their future earnings and as a result improving the valuation of the enlarged group. The best guide to assessing the future earnings of any prospective target is to look at their historic, current and forecast earnings. However, this may not paint a true picture, many private companies are not run to maximise profits; due to a natural reluctance to pay large amounts of tax. So when presenting financials to a buyer, adjustments need to be made to calculate the “underlying earnings”. While these adjustments are common the fewer adjustments that are made the better.
Excess staff
remuneration
Packages to
staff that
are above market
norms may be
viewed as quasi-equity
and adjusted.
A recent client
paid significant
bonuses to
staff in lieu
of equity participation
in the deal,
so clearly
that needs
to be added
back.
Benefits
This can include
all sorts of
expenditure
which is common
in private
companies but
tends to be
tolerated less
in the post-Enron
environment
at Plcs. As
well as the
obvious expenses
like entertaining,
other real
life examples
include: the
running costs
of a team of
racing cars,
the payment
of little Johnny’s
school fees,
membership
of Loch Lomond
Golf Club;
a £150,000
staff party
and the overseas
holiday home.
Non-recurring
items
These are usually
large one-off
items. Whether
they are actually
defined as
exceptional
items in the
audited accounts
is largely
irrelevant,
although it
certainly makes
the inclusion
of an item
easier to justify.
Unusually large
bad debts,
unusual professional
fees, losses
on discontinued
or sold business
divisions,
losses on foreign
exchange transactions
or asset disposals
are examples
that may fit
into this category.
Interest
Most purchasers
tend to look
at operating
profits and
will therefore
exclude all
interest payable
or receivable.
Once the underlying earnings of the company have been established, this will form the basis of a purchaser’s valuation, however, further adjustments may well be needed by the buyer to account for: differing accounting policies, rates of depreciation, software amortisation amongst other things. The more transparent a vendor is in disclosing the financials the better.
Multiples
Multiples used in valuation can vary enormously and are determined by a number of factors, many of which are outside the vendor’s control.
Listed comparibles
First, and
foremost, multiples
used in valuing
private companies
have a direct
relationship
with the value
of comparable
listed companies.
Just ask anyone
connected with
PWC Consulting
who saw its
value drop
from a mooted
$18bn from
HP to an eventual
$3.5bn when
acquired by
IBM eighteen
months later.
Strategic
premium
Secondly, a
strategic buyer
will always
be prepared
to pay a premium
over a tactical
or financial
buyer, as their
earnings will
benefit from
the deal through
a combination
of:
a. Cost savings – profits will be boosted by cutting costs, for instance, cutting the accounts department or closing duplicate offices or manufacturing plants.
b. Revenue synergies – companies will often make acquisitions to plug a significant product or skills gap in their portfolio, particularly overseas buyers who need to build a global network quickly and efficiently to service their international accounts.
c. Opportunity cost – the acquisition may benefit the strategic buyer in indirect ways. For example, we sold a wireless services company to a financial institution that was able to bring to market its new wireless financial product a lot earlier by deploying the acquired wireless engineers, justifying a premium price.
Growth
Buyers want
growth, and
are prepared
to pay for
it. As a very
rough rule
of thumb a
listed company
that can grow
profits or
sales at 30%
annually will
warrant a PE
x 30 whereas
one growing
at 10% will
only have a
PE x 10. So,
build a robust
and compelling
growth story.
Selling a business
at the peak
of the business
cycle is too
late, you need
to leave something
on the table
for the buyer.
He needs to
buy into your
vision for
growth to justify
paying a premium.
Profit records
A business
that has a
consistent
record of profitability
will be worth
more than a
one-year wonder.
You need continuity
to build confidence
in the business
model. Recurrent
business, non-reliance
on one customer,
longer term
contracts and
substantial
order books
all reduce
risk to a buyer
and therefore
justify a premium
in the multiple.
Commitment
Show commitment
to the buyer
to help reduce
handover risk.
Most deals
nowadays have
an earn-out
or partial
deferred payment
to retain and
incentivise
management
to stay. If
you are an
owner/manager
and have a
fixed date
that you want
to exit by,
then you are
better selling
the company
early, unless
you’re
not really
involved with
the day-to-day
management.
Flexibility
Be flexible,
every vendor
wants cash,
yet most purchasers
want to use
shares. There
is usually
a compromise.
Recently, most
of the deals
we have seen
in the market
have actually
been all (or
substantially
all) cash,
but as equity
markets recover
shares will
be used again.
Vendors that
were enticed
by notionally
high valued
equity deals
in the last
bull market
had their fingers
burned. There
is a base price
for a business
that clearly
needs to be
in cash, but
taking some
equity shows
commitment
and enthusiasm
to the purchaser.
An earn-out
can also be
a useful way
of increasing
value, linking
future performance
to returns.
“Buyers want growth and are prepared to pay for it, so build a robust and compelling growth story”
