Valuing a company for sale is some science with a lot of consideration to art
By Gary Miller – Managing Director, Consulting Division, SDR Ventures
Last month in New York, 100 CEOs, bankers and lenders at a conference were asked for their thoughts about middle-market merger and acquisition activity for the second half of the year.
Top of mind among dealmakers: 58 percent thought valuations are too high, and 23 percent thought business owners have unrealistic pricing expectations for their companies.
Many sellers of midsize businesses are unfamiliar with how to value their companies. Most successful business owners will hire an investment banking firm or a third-party valuation firm to bring them a realistic estimate.
But what if your adviser comes back with a price lower than you expected? Isn’t valuation as simple as applying a relevant revenue, earnings before interest taxes depreciation and amortization, or free cash-flow multiple to your business?
While multiples provide helpful data points, conducting a thorough valuation is much more complex — and it is not an exact science.
A reputable banker is going to start a robust valuation exercise by using multiple methods to narrow in on the right value range. Once the numbers have been crunched, a banker is most likely going to end up with a handful of independent estimated values for your business.
Here’s where the real work begins. For each method, a banker is going to consider a variety of non-quantitative factors and adjust the valuation accordingly.
Let’s look at some of the most common valuation methodologies that a banker will use to estimate the value of your business.
Discounted Cash Flow, or DCF: If bankers had a crystal ball into the future, a DCF analysis would be a great way to value a business. In reality, DCF analyses involve a huge amount of discretion in projecting what a company’s business will look like for the next five to 10 years. Operational assumptions for the model are typically provided by a company’s management team, so a banker needs to consider that the data rely heavily on management’s ability to predict the future accurately.
Most buyers, as they start to negotiate with the seller, are going to attack many of the assumptions that have been made about future growth. If the owner and the banker understand which line items are highly predictable and which are more variable, the banker will be able to estimate a more accurate valuation and help the seller negotiate.
Trading Comparables: Analyzing trading-comparable multiples reflects real-time and real-world valuation data. The key consideration is to ensure that the banker has the right universe of peer companies — which companies reflect most closely to yours in terms of size, product mix, growth potential, market segments and other major considerations.
Bankers ideally will evaluate five to 15 peer businesses, focusing on the companies that look most like your business, and weight those companies’ multiples more heavily than the group’s average.
Transaction Comparables: Using transaction comparables is another common methodology, but it can be hit-or-miss. The challenge with transaction comps is that often there are few, if any, truly comparable transactions for a banker to consider.
When such data are available, a banker isn’t going to know what portion of the price paid was stand-alone valuation and what portion was attributable to other factors, such as synergies, management strength and culture fit. And finally, the timing and age of the transaction matter because market conditions and industry sector dynamics often change rapidly.
For these reasons, transaction comparables can run the gamut from being virtually ignored to being the linchpin in a valuation process.
As an industry insider, you’ll likely have information about recent company acquisitions your banker isn’t aware of. By providing your banker with more details, he or she can build a more realistic valuation model for your business.
If it sounds like conducting a high-quality valuation analysis isn’t quite as formulaic as you thought, that’s because it’s not.
No method can truly account for all the attributes and idiosyncrasies of a particular business. The best banker will account for as many variables as possible and settle on a valuation range that makes the most sense. By staying involved in the process and providing information for your banker, you can help ensure getting to the most realistic valuation range.
And remember, the only true financial value of your business is the price that a serious buyer is willing to pay.
Gary Miller is a managing director at SDR Ventures, a Denver-based investment banking firm. Gary specializes in strategic business planning, mergers and acquisitions advice, exit-strategy consulting and post-integration services. Contact: 720-221-9220 or firstname.lastname@example.org.
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