If you’ve decided to sell your company so that you can retire or move onto new projects, how do you arrive at an appropriate estimate for the market value of your business that will form the basis for negotiations with a potential buyer? myLIFE offers several tips on how to go about this complex exercise.
A business transfer is a procedure that is riddled with pitfalls for an entrepreneur. It requires meticulous preparation and planning in several stages – consideration of your personal goals, an assessment of the company, the search for a buyer, negotiations, etc. One crucial stage is estimating the effective value of the business – this means valuing the company.
This is often a difficult exercise as there is frequently a gap between the objective value and the subjective perception of the value of the company. A company boss who has poured all of their energy into managing their business and expanding it – sometimes at great sacrifice – may lack objectivity when it comes to assessing the fruits of their labours. This is one reason why it is advisable to call on a valuation expert who can carry out a full and objective analysis of the company, taking into account any external elements likely to influence the outcome of the assessment.
→ Useful info: valuation is an essential part of a business transfer but it may also be useful at different stages in the life of a company, such as fundraising rounds, an IPO or merger, or if the capital is opened up to investors, etc. In addition, a regular assessment of the value of the business enables an entrepreneur to understand how healthy the business is over time and, where necessary, to adjust its strategy to improve results.
Valuation provides a range for the value of the company, which will serve as the basis for negotiations, rather than an exact price.
Various valuation methods
There are many and varied methods for estimating the economic value of a company. Each method has its own characteristics, advantages and disadvantages and may or may not be appropriate to the profile of the company.
Some are focused on the assets of the company, others on its performance, profitability, future cash flows (earnings, dividends, cash flow, etc.). Other methods are based on similarities with equivalent structures, comparing transactions or financial data, and applying ratios or multiples to earnings, etc.
The outcomes may vary enormously from one method to another. It is therefore interesting to combine several methods to obtain the most appropriate valuation possible.
→ Useful info: it is important to understand that valuation provides a range for the value of the company, which will serve as the basis for negotiations, rather than an exact price. The actual price will depend on the context of the sale (economic outlook, urgency of the transaction, number of potential buyers, etc.) and, of course, on negotiations with the buyer.
By way of illustration and without going into the detail of the calculations, here are three methods that may be used to value a company. For more detailed explanations, contact an expert. In addition, we must once again insist on the importance of combining several methods to arrive at the most objective valuation possible for the company.
The asset-based method
This approach assumes that the company is worth what it owns. It is based on the current and past performance of the company and takes no account of its growth potential or profitability.
It consists of listing all of the assets the company (tangible assets, inventory, cash, trade receivables, etc.) and deducting debts and provisions (liabilities), based on the latest balance sheets. The data is then analysed and reassessed at market values to arrive at an adjusted net asset value that is closer to the economic reality.
The cash flow or future earnings-based method
This method is also called a Discounted Cash Flow (DCF) and considers the profitability of the company based on its future cash flow generation. It assumes that the company is worth what it will generate.
In concrete terms, this method is based on the company’s business plan and its forecast cash flows for, say, the coming three to seven years. A discount rate that reflects market conditions is then applied, and a terminal value is estimated for the company for the period after the years included in the business plan. The present value of the company corresponds to the sum of the discounted cash flows and terminal value.
The comparative or market value-based method
This approach assumes that a company is worth the same as other companies with the same profile.
It consists of choosing a panel of companies for which the value is known (because they were recently sold or are listed, etc.) and which have similar characteristics (geographic location, size, business area, growth prospects, etc.). The company to be valued is then compared to those in the sample using various multiples of its results: turnover, net income, gross operating income, cash flow, etc.
Estimating the value of a company must reflect tangible as well as intangible factors.
Consider the advantages, weakness and unique attributes of the company
Estimating the value of a company must reflect tangible as well as intangible factors. In addition to accounting data, asset values and future earnings of the company, other elements – that are sometimes difficult to quantify – must be considered.
These include factors related to its operations (employee relations, the distribution network, dependency on the CEO, etc.), as well as company-specific factors (the skill sets of its teams, any patents or in-house technologies, the client portfolio, reputation, etc.), and of course, the influence of its external environment – competition, market momentum, the general economic outlook, legislation applicable to its business area, etc.
A loyal and committed client base will have a positive impact on the valuation of a company, whereas a poor reputation or high dependency on the CEO will reduce its market value. It is tricky but essential to assess the impact of these intangible factors. The gap in the assessment of the buyer and the vendor is often greatest at this level.
Goodwill or excess value
We can add what is referred to as goodwill to the results obtained by the asset or earnings-based valuation methods. This refers to an additional value for the company to reflect intangible elements – its reputation, brand image, know-how, culture, client base, etc.
Goodwill refers to the excess of the price paid to acquire the company over its book value. On the other hand, if there is a deficit, this is referred to as badwill, which may be caused by a loss of clients, a deterioration in the company’s image, etc.
It is quite clear that estimating the value of a company is a complex exercise which cannot be made up as you go along, and which calls for a cool head. It requires solid accounting and financial skills and sound knowledge of the company’s business sector. It also requires the capacity to reflect many diverse intangible factors.
For all of these reasons, it is highly advisable to involve an accountant or a banker specialised in corporate sales or transfers to arrive at a full and objective valuation, and to be in a position to justify any choices made to a buyer. Good luck!