Business Valuation

Factors Influencing Business Valuation

Many factors have to be assessed to determine fair valuation for an industry, a sector, or a company. The key to valuation is finding a common ground between all of the companies for the purpose of a fair evaluation. Determining the value of a business is a complicated and intricate process. Valuing a business requires the determination of its future earnings potential, the risks inherent in those future earnings, Strictly speaking, a company’s fair market value is the price at which the business would change hands between a willing buyer and a willing seller when neither are under any compulsion to buy or sell, and both parties have knowledge of relevant facts. The question that then arises is “How do buyers and sellers arrive at this value?” Arriving at the transaction price requires that a value be placed on the company for sale. The process of arriving at this value should include a detailed, comprehensive analysis which takes into account a range of factors including the past, present, and most importantly, the future earnings and prospects of the company, an analysis of its mix of physical and intangible assets, and the general economic and industry conditions.

The other salient factors of business valuation include:

1. The stock exchange price of the shares of the two companies before the commencement of negotiations or the announcement of the bid.
2. Dividends paid on the shares.
3. Relative growth prospects of the two companies.
4. In case of equity shares, the relative gearing of the shares of the two companies. ( ‘gearing’ means ratio of the amount of issued preference share capital and debenture stock to the amount of issued ordinary share capital.)
5. Net assets of the two companies.
6. Voting strength in the merged (amalgamated) enterprise of the shareholders of the two companies.
7. Past history of the prices of shares of the two companies.

Also the following key principles should be kept in mind:

• There is no method/of valuation which is absolutely correct. Hence a combination of all or some may be adopted.
• If possible, the seller should evaluate his company before contacting potential buyers. Infact, it would be wiser for companies to evaluate their business on regular basis to keep themselves aware of its standing in the corresponding industry.
• Go for a third party valuation if desirable to avoid over-valuation of the company which is a common tendency on the seller’s part.
• Merger and amalgamation deals can take a number of months to complete during which time valuations can fluctuate substantially. Hence provisions must be made to protect against such swings.

Business Valuation Motives

An important aspect in the merger/amalgamation/takeover activity is the valuation aspect. The valuation of business, however, depends to a great extent on the acquisition motives. The acquisition activity is usually guided by strategic  behavioral  motives. The strategic reasons could be either purely financial taxation, asset-stripping, financial restructuring involving an attempt to augment the resources base and portfolio investment) or business related (expansion or diversification). The  behavioral  reasons have more to do with the personnel ambitions or objectives (desire to grow big) of the top management. The expansion and diversification objectives are achievable either by building capacities on one’s own or by buying the existing capacities. This would effectively mean a “make (build) or buy decision” of capital nature. The decision criteria in such a situation would be the present value of the differential cash flows. These differential cash flows would, therefore, be the limit on the premium which the acquirer would be willing to pay. On the other hand, if the acquisition is motivated by financial considerations (specifically taxation and asset-stripping), the expected financial gains would form the limit on the premium, over and above the price of physical assets in the company. The cash flow from operations may not be the main consideration in such situations. Similarly, a merger with financial restructuring as its objective will have to be valued mainly in terms of financial gains. It would, however, not be easy to determine the level of financial gains because the financial gains would be a function of the use of which these resources are put finally, the pricing of behaviorally motivated acquisitions is not really guided by the financial considerations. Since the acquisitions are not really the market driven transactions, a set of non-financial considerations will also affect the price. The price could be affected by the number and the motives of other bidders. The value of a target is effected not only by the motive of the acquiring company, but also by the target company’s own objectives. The motives of the target company could also be viewed as to be strategic, financial or  behavioral.

Read More:

• Adjusted Book Value Method of Corporate  Valuation
• Business  Valuation  using Discounted Cash Flow Method
• Alcar  Model of Value Based Management
• McKinsey Model of Value Based Management  
• Marakon Model of Shareholder Value Creation