Valuations – depends who you ask

Corporate finance can be a complex subject, but it’s also one of great interest, especially if you own a business you hope to sell at some stage in the future. It’s human nature to try and simplify the complex and this seems to hold true for explanations of a firm’s value. This is unfortunate and fans the flames of unrealistic expectations. Below are a few scenarios you might recognise, along with a high level explanation of how a valuation is generally constructed by a reasonable purchaser.

The Journalists View

If you don’t fully understand something, have incomplete data, or if it’s too complicated to explain in headlines or tweets, you need to find a shortcut. The average press release for a transaction rarely provides more than the maximum possible consideration and the amount payable at completion. The last recorded EBITDA figure is fairly easy to obtain and dividing the total consideration by that number, gives you a multiple and a headline. Simple, but totally flawed, as the EBITDA figure used for the deal will have been normalised and a valuation is not the same as an offer.

The Business Brokers View

Just like estate agents, business brokers generally need a transaction to complete in order to get paid. It’s easy to throw around big numbers (few question the validity) and it gets business owners engaged in a deal. Once you are past heads of terms, there are a number of good reasons why you are likely to complete. The broker rarely cares if the price gets chipped as a result of due diligence, as they are on a percentage. A deal at £750k with a 3% broker fee, nets £22,500. If they get you another £100k, they only get another £3k. The economics motivate the broker to reel in as many vendors as possible (with big numbers) and spend the minimum time possible in order to get a deal completed, regardless of price. 

The Successful Vendor’s View

If you’ve just had your wrist put up between your shoulder blades, the last thing you’re going to do is tell all your peers about it. And unless you’re Herb Cohen, you’ll be wanting to stay on the right side of the purchaser, so you get as much of your deferred consideration as possible. By the time warranties and indemnities are extinguished and you’ve had whatever deferred consideration you’ve been lucky enough to trouser, the market will have moved on and news of the actual method used to calculate the amount paid for your business 3 or 4 years ago, will be largely irrelevant. Extrapolating from incomplete data is understandable, but not a single example (of someone selling a business) and especially not where the missing data is fundamental to the outcome.

The Purchasers View

Why on earth prospective vendors take price guidance from prospective buyers is beyond me. If someone is looking to buy your business, they are actually looking to sell you their deal. There’s plenty of buyers and therefore plenty of competition for good quality firms, so it pays to remember who you’re talking to.

The Inconvenient Truth

A business is worth what someone is prepared to pay for it. A cliché for sure but there is a hidden truth in there. The amount you are offered for your business, has far more to do with the purchasers business model, their cost of capital, exit plans and the motivations of those responsible for acquiring your firm. Any credible purchaser will have a method for valuing their own business and will create an acquisition model that helps them buy assets at a lower value than their own, with consideration for their cost of capital. There’s nothing wrong with this approach if it’s done well. Indeed, if you were in their shoes, you’d look to do the same. What is important, is to be aware of what’s going on in a negotiation, so you avoid looking daft, or worse, handing your business over at well below its actual value.

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