“An object’s true worth is not what you say it is, but actually
what someone else is prepared to pay for it in an honest transaction”
A company’s value is a crucial element in many decisions made by owners and managers of a company. This article seeks to answer some basic questions about valuations, why they are important and what you should be aware of when undertaking a valuation exercise.
Why do a valuation?
Businesses undertake valuations for a number of reasons. These include undertaking a corporate transaction, raising capital, designing an incentive structure, entering into an insurance contract or a host of other reasons. Whatever the reason, having a competent valuation of your business is a worthwhile exercise.
What is a valuation?
A valuation is a detailed analysis of the constituent parts of a business with the intention of establishing the likely value that a business would transact at under a set of assumptions. In theory easy, in practice rarely so. There is no business / transaction exactly the same as another, so whilst market based evidence is useful it is not a perfect predictor.
Concepts such as Fair Market Value, Free Cash Flows and Weighted Average Costs of Capital can intimate and confuse the business person. In reality, business valuations include some weighty theory which may be difficult to understand by simply trawling the internet. Practical expertise and market knowledge of what value businesses trade at is also vitally important to the valuation exercise.
How to do a valuation?
Valuations at their core are about considering the past performance and the future expectations of the business. They are a combination of theory, pragmatism and experience.
Doing a valuation yourself is possible, but it is a bit like “marking your own homework”. An objective and independent valuation can often highlight unknown aspects of the business that may enhance or reduce the business value.
Valuations undertaken by professionals use a combination of methodologies. These may include:
- Asset based
- Capitalisation of earnings
- Discounted Cash Flow
- Dividend based
- Comparable transactions
Each method involves the application of a certain rules and assumptions and can often lead to very different outcomes.
What does a valuation mean?
A valuation can be undertaken for various reasons and hence no one valuation can satisfy all circumstances. A valuation is a subjective view based on facts presented, which have not necessarily been verified. Hence, a valuation is often useful for establishing a range for values. It serves as a guide rather than an absolute statement of what two parties would transact at.
Who should I trust to compile a business valuation?
No one individual has perfect knowledge about your business and the risks and opportunities facing it. However, a skilled and experienced professional valuator does possess the expertise to crystallise all the rights, obligations, projections, and risks attached to a specific business.
Valuations are generally priced on the basis on which the valuation will be used. Contentions matters such as litigation will likely involve considerably more time and effort than an informal guide on price – hence the cost of undertaking such an exercise varies considerably. The quality of service and hence fees is not a linear relationship and clients would be well advised to seek comparative assessments of costs rather than accepting the first fee estimate.
Ask the following questions when you wish to make use of a valuation expert:
- What kind of valuations have you performed in the past?
- Provide examples of transactions you been involved in?
- What documents would you require to complete a valuation?
- What is your process for undertaking a valuation?
- How do you propose charging for your service?
These questions will help get the relationship on the right path between a professional and their client.
Should you wish to discuss how to value your business or require assistance in undertaking a corporate transaction, please contact me.