Are you looking to get your business valued? Here’s a bit of information to help you understand the process we follow.
Process
Any business valuation begins with a discussion with you. We’ll discuss the purpose of the valuation, whether the valuation should be discounted to account for a minority interest, if there are different rights attached to the shares being valued, and other key questions like market pressure.
Many business constitutions or shareholders’ agreements include guidance on how the business is to be valued i.e. fair market value. We’ll check on this and comply.
The information typically required for a business valuation includes:
- 3 years of financial statements (if available)
- Financial forecasts/projections
- Overview of business roles and duties
- Strategic plan
- Wider discussions with management around the market and business model
Valuation methodology
Here are the three most common methodologies.
Discounted cash flow (DCF): It is a fundamental principle that the value of an asset is represented by its future cash flows, discounted to a present value at a rate that reflects the risk inherent in those cash flows. Stay with us... In practice, it is often difficult to obtain robust forecasts for future cash flows over a sufficient period to apply the DCF methodology (three years as minimum and, preferably, five years or more).
Capitalisation of earnings (CE): Where we cannot obtain accurate cash flow forecasts for a sufficient period, we’ll often use the CE methodology as a surrogate for the DCF methodology. Under the CE approach, value is determined by capitalising an assessment of future maintainable earnings, at an appropriate earnings multiple. Assessing future maintainable earnings requires a number of ‘normalisation’ adjustments. These ensure that the maintainable earnings figure accurately reflects earnings related to business operations and that this can be compared across the industry in which the business operates. Typical adjustments include excess directors’ salaries, insurance pay-outs, and extraordinary events.
Covid-19 has had a significant impact on businesses. Under this scenario, it is our view that the normalised earnings process remains the same, however the multiple used to capitalise those earnings changes based on competitive landscape, impact of Covid-19, consumer confidence, digitalisation, investment, and other relevant factors.
Both the DCF and CE approaches determine value by capitalising an assessment of future maintainable earnings, at an appropriate earnings multiple. Both the DCF and CE methodologies assume a 'going concern’ business.
Many factors influence value attached to a business. These include:
- Historical profits
- Income risk
- Terms of sale
- Business type and growth
- Location/facilities
- Marketability
- Desirability
- Competition
- Industry
- Competitive advantage
- Concentration risk – product, service, customer, supplier, key people
Net tangible assets value (NTA): Still with us? An alternative approach to business valuation that is sometimes used as a crosscheck on the results of the above approach is NTA. The NTA approach assumes that all the economic value of a business derives from its productive assets. It involves estimating the net realisable value of individual assets and liabilities, the aggregate of which reflects the fair market value of the business, normally calculated on a liquidation basis. The approach can be used in situations where the future prospects of the business are poor or uncertain.
The higher of NTA and DCF/CE approach is used to determine value.
It is important to remember the difference between enterprise value and equity value. The enterprise value is effectively the value of the entire business including debt. The equity value of a business is different, in that it represents the value of the business available to equity holders – it is therefore calculated by stripping out net debt from the enterprise value and adding back surplus assets.
If you would like to discuss a valuation for your business, give us a call on 03 379 6710.
