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Valuation of the Company

Any valuation is subjective. This fact is know for both parties.  However, any negotiations without the presence of certain appraisal reports or “fair market value” calculations are not likely to go very far. To our clients we suggest to prepare a valuation analysis prior to the negotiations and use it as a basis for price discussions during the negotiations. For smaller transactions (up to $50 million), the calculation of the fair market value does not necessitate the hiring of a large audit company. It is just waste of money since the job will most likely be outsources to India anyway.  The bankers who represent the interests of the seller should be totally qualified to prepare the valuation analysis. The sellers may discuss the valuation summary with their CPAs to get better understand of the tax implications of the sale (it is especially true of the sale may be structures of the asset sale).

At the beggining of the sale process there is large imbalance between the parties regarding the possession of inside information. The owners of the company know the real state of affairs, and are almost always unwilling to reveal hidden risks only known to them not only to potential buyers, but sometimes also to their bankers.  It is understandable.   The argument to the owners defense is that it makes little sense for any reasonable owner of a target company to present the company's weaknesses since it does not help with the sale.  Potential biuyers will spend significant amount of time and money trying to find problems or potential problems with the target company later and at this point any problem disclosed by the Sellers will be used against the Sellers during the negotiations.  It makes no sense to misrepresent the state of affairs but it is stupid and naïve to be overly honest.

There is no perfect method for calculating the value of a company. There are methods that are recognized by the courts and arbitrators. Therefore, these recognized methods are used.  Examples of the most commonly used methods are (1) the DCF analysis (discounted cash flow method), and (2) the market method (which compares information on the price and conditions of “similar” transactions). Sometimes, the method of calculating the value is based on the market value of companies operating in similar industries whose shares are traded on a stock exchange, of course with all kinds of adjustments.

The most appropriate approach is probably the market method, which calculates the possible value by using similar comparable transactions.  However, as you have probably noticed, almost always prices for transactions are not publicly disclosed. The commonly written cliché used in the deal announcements is as follows: “The parties have decided not to disclose the terms of the transaction.”  Imagine that you are negotiating with a large corporation. Since large companies constantly make acquisitions they have the full picture of the exact terms and prices of the transactions which they closed. The Buyer will possess much more information and know the appropriate “market” prices and the Sellers are left “in the dark”.


 

We have provided several useful, free resources for potential Sellers. If you want to further discuss how we can assist you in evaluating your company, or preparing to negotiate a price with a potential investor, please contact us.


Free materials and financial models to calculate the value of a company:

  1. At this link, you can see an example of a report on the calculation of the value of a company. In order to maintain confidentiality we have removed some of the information, but if you know the basics of finance, you will have no difficulty in understanding the logic. The presentation showing this sample valuation can be downloaded here;
  2. A report on the possible methods of valuation (PDF in English available here);
  3. Version of a financial model used to calculate the likely cost of capital (Excel model in English available here);
  4. Guidelines for the selection of the optimal method of valuation (Excel file in English available here).

Attention: Remember, the most important factors in any financial model are the variables and assumptions that are placed into the financial calculations. There is nothing magical in any financial model, be ready to defend your assumptions not your model!

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