Professional Valuations Can Help Resolve Pricing Discrepancies

Business sellers often are dismayed to find that buyers don’t put as high a price on their companies as the sellers believe they deserve. By the same token, buyers that paid an above-market price often are frustrated when acquisitions don’t deliver the anticipated financial reward.

One reason for such discrepancies is that the selling business hasn’t been properly appraised. A professional valuator can provide an objective way to view a company and price a deal.

Assist with Information

Business owners should seek an appraisal early in the M&A process. A valuation report gives sellers an idea of how much their companies are worth and may offer insights into how owners can improve their business model before putting the company on the market. A valuation may be performed independently of an M&A transaction or performed as part of deal negotiations.

To help valuators make a fair and accurate appraisal, sellers need to provide them with information on:

• Financial performance
• Marketing and sales
• Operations
• Products and services
• Vendor and customer contracts
• Tangible assets and inventory
• Intangible assets, such as intellectual property

For their part, buyers should scrutinize any assumptions the valuator uses — both about the company and the industry. If buyers have information that contradicts anything in the initial valuation report, they should discuss it with the appraiser before the final report is issued.

Assess Underlying Assets

Valuators may use one or more methods to arrive at a business value. One common approach is the asset-based method, in which an appraiser determines the fair market value of the business’s underlying assets minus the fair market value of its liabilities.

This method focuses on the tangible value of the business’s underlying assets and may be appropriate when a company’s profits are so small they don’t contribute to its value. It may also work for businesses whose value lies in the worth of their individual assets rather than their earnings streams — for example, real estate and investment companies.

Go to Market

With the market approach, a valuator may use multiples that are the mean or median ratio of the transaction price at which similar companies have recently sold, as a multiple of their annual gross sales (price/gross sales). Or the appraiser may use multiples that are the mean or median ratio of earnings as a multiple of the transaction price for which similar companies have sold (price/earnings).

Market multiples are good for getting a “feel” for a company’s value. Unfortunately, valuators don’t usually have pertinent details of each company’s sales transactions. And information might not be available regarding, for example, the comparable companies’ expected future growth rates. For these reasons, the market approach typically is used as a “reasonableness check” to supplement the value determined by another method.

Discount Cash Flow

The discounted cash-flow (DCF) method measures the value of a company’s expected future cash flows, as discounted to present value. This approach has several steps.

First, the valuator adjusts five years of the company’s historical financial statements to market value. The appraiser then converts expected after-tax net income to free cash flow for several future years by adding depreciation, amortization and interest expense (net of taxes), subtracting amounts for expected capital expenditures and working capital requirements. Next, the valuator discounts each projected year’s free cash flow to present value by discounting the respective amounts using a risk factor (the discount rate).

Capitalize on Economic Benefits

The capitalization of cash flows approach is a method whereby economic benefits for a single representative period are converted to value through division of a capitalization rate. Under this method, expected annual future economic benefits — cash flows — are used as a proxy for all future benefits.

This method isn’t appropriate for financially volatile companies. It’s generally applied when a company’s future earnings are expected to be fairly steady.

Many Factors

Keep in mind that a valuation report is only one factor in a company’s ultimate sale price. Some buyers are willing to pay more because, for example, they’re competing against other bidders. And sellers may be willing to accept less because they receive certain deal terms or other concessions.

© 2017