Determining the value and set price is one of the most important decisions that you’ll make when
going forward with buying or selling a business. VR can help you with
the many considerations that you have to make when doing a valuation.
If you’re looking to buy
or sell a business, VR will provide you with solid and reliable assistance. Every
VR business intermediary is highly trained in bringing both parties together to
coordinate the negotiations and activities of the transaction. Here at VR, we
can provide a thorough and accurate valuation of the company to establish the
fair market value and potential listing price.
TYPES OF VALUATION
Discounted Future Cash Flow and
Multiple of Earnings are two methods that VR uses in the valuation of small and
mid-sized businesses.
Discounted Future Cash Flow
This analysis is based on the
projection of earnings for three to five years and the resulting cash flows for
each year. These are discounted to their present value at an appropriate rate that’s
based on the buyer’s perception of risk in the business.
Buyers expect the same kind of
return on a business acquisition as they would realize on other investments of
similar risk.
In order to assess this, a buyer
needs to consider such factors as:
- Credibility
of pro forma projections for sales and earnings;
- Risk
inherent in the target company’s industry;
- Weighed
average cost of capital taking into account both the cost of debt and equity.
Multiple of Earnings
In the public market, this method
can be used when valuing a closely-held company. Most of these are likely to be
subject to a much lower price-to-earnings (P/E) ration than a publicly-held
corporation, if you’re a party that’s dealing with a private business.
This ration stems from the fact
that a smaller business doesn’t represent the same liquidity as an investment
in public stock. Therefore, if publicly-comparable P/E multiples are used to
estimate the value of a private corporation, then they will likely be discounted
based on the marketability.
IMPORTANT CONSIDERATIONS TO NOTE
There are many considerations when
assessing the risk of the subject business that should be made when estimating
its value.
The most important considerations
are:
- Stability of Historical Earnings;
- Future Projections;
- Performing Due Diligence;
- All Assets and Liabilities Included
in the Sale.
Stability of Historical Earnings
A potential buyer will first look
at the stability of historical earnings when estimating the price for a target business. Excessive add-backs, adjustments to the income statement and
inconsistent profit margins decrease the overall marketability. Generally, a weighted average of the last three to five years
is used, if the last twelve months of earnings are inconsistent.
In developing an accurate
discounted future cash flow analysis, it is critical that the pro forma income
and cash flow projections be realistic and supportable. Aggressive growth
projections, when not backed up by good market research of the business being
valued, can carry high risk factors. As a result, the rate of return that’s
being used will increase.
On the other side, conservative,
well-supported growth forecasts result in highly credible cash flow projections
that are deemed to be relatively low in risk.
A clear supporting mechanism for
pro forma projections can be seen by comparing business plans and budgets from
prior years. This will provide a clear indication of how well management plans
each year and how often they will meet, exceed or fall short of their
projections.
Performing Due
Diligence
If you
want to value a business properly without exception, performing due diligence is
the most important aspect of valuation. There are two areas that need attention
when verifying information: Financial and Operational.
- Financial due diligence involves
verifying add-backs or adjustments to income statements, account
receivable/payable analysis, inventory audits and fixed asset analysis.
- Operational due diligence generally
gets overlooked. It involves verifying customer relationships and their
contribution to the subject business’ annual revenues, reviewing supplier
relationships, management strength and analyzing the market for potential
customers and competition.
All Assets and
Liabilities Included in the Sale
Inventory
all actual items that are included in the sale such as intellectual property
(patents and copyrights), personal vehicles, real estate, shareholder loans,
receivables, third party notes and all other liabilities.