Thornton: First of all you have to understand the business that you are valuing, the industry in which it operates and what drives value. Then you can assess the most appropriate method by which to value the business taking into account issues such as business lifecycle, expected growth and sector considerations.
In valuing any business, there are three main methods of valuation that can be used: asset, income and market. Each method has advantages and disadvantages and ideally more than one method should be used as this will help triangulate value. You also have to understand any industry benchmarks that might apply.
Valuation has often been referred to as an art rather than a science and, given that there is always some subjectivity involved, that is understandable, but valuation opinions should always have some analytical support. It is not just a financial modelling exercise — it has to be backed up with experience and a real world view.
Dudley: While the overall entity will be reviewed primarily using a market approach, taking into account similar transactions and with research into the wider industry context, and an income based approach using a discounted cash flow analysis, any underlying asset value in tangible and intangible assets may focus on a market approach but also incorporate the cost approach where appropriate.
For asset-based valuations, a full and thorough site-based asset discovery process may be necessary; while the fixed asset register is an audited document, it can be misleading as a true indication of the company asset base in terms of more informative factors such as production capacity. Experience in the specific industry is essential. A wide range of approaches provides further justification of the conclusion; if a single comparable transaction is viewed to be inappropriate for any reason, the supporting arguments from the other approaches can provide validation for the overall outcome.
What options are available for parties looking to understand and manage underlying risks? Dudley: There is a broader scope that a valuation provider can assist with across all stages of the business transaction. An understanding of the target requires a thorough appraisal of the associated risks and opportunities, including options to raise financing, potential restructuring and asset discovery and verification. We firmly believe that you should leverage the expertise of your valuation expert across all of these areas.
The valuation expert needs to be explicit in their statements of analysis, inputs and assumptions to mitigate the associated risks.
A lack of clarity is effectively the same as an incorrect assumption, and leaves the combined company open to future litigation. As a result, financial advisers have instituted more rigorous internal review processes that involve greater involvement of senior bankers. Law firms have responded to this risk by involving litigators early in the deal process.
A second challenge to the valuation process is the impact of an uncertain global economic outlook on estimates of long-term company or industry growth rates. Declining or staccato growth and more cautious consumer spending, even where unemployment rates have moderated, produce significantly divergent estimates of long-term growth that, in turn, drive divergent estimates of value. Thornton: Valuation relies on information so the biggest challenge can be having enough information from which to draw a sensible conclusion and to support the key assumptions underpinning valuation.
Understanding the business and its growth prospects is critical — valuation is forward looking and certainly buyers acquire businesses on the basis of what they expect to achieve from the business. The key is therefore to identify the competitive advantage and how that can be brought into the valuation. Value is what you get. How do objectivity and potential conflicts of interest come into play? As the focus on so-called banker conflicts has shifted to the multifaceted relationships that financial advisers maintain with targets, acquirers and sources of deal financing, the second financial adviser is now expected to fulfil a more robust advisory role that expands beyond providing a fairness opinion.
The use of a second financial adviser appears to have provided some additional protection to boards. Thornton: Much of the demand for an independent opinion is driven by the need to address conflicts of interest whether actual or perceived. There are often different groups of stakeholders involved in a transaction who will have different perspectives. Equally, there may be connected parties involved and a need to confirm that the transaction is fair and reasonable. The opinion from an independent firm can therefore be essential to provide comfort to the parties involved and provide a degree of protection to the board.
Dudley: The issue here is when a party that is already an integral part of the transaction is also instructed to provide a fairness opinion — their independence and objectivity could be questioned if there is potentially a conflict of interest, especially when they benefit from a successful conclusion of a transaction. In this case, a second opinion would be sought from another party.
Methods of valuation for mergers and acquisitions solution | Mindtree
Although the immediate benefit may not be clear to the board, ultimately this action is to prevent future issues that could stem from any doubt over the fairness opinion which could jeopardise the success of the transaction. Dudley: The key factors are independence and objectivity. If deemed necessary, the special committee should incorporate both directors with no financial interest in the success of the transaction, as well as independent advisers.
The process and remit of the special committee should also clearly direct all members toward an independent decision. This approach is useful where there are actual or perceived conflicts of interest for the board or individual directors, and in the event of future litigation it can prove invaluable to both a shortened and successfully resolved legal process. Austin Smith: From the perspective of a financial adviser, the effectiveness of a special committee in facilitating the satisfaction of fiduciary duty depends, in part, on two factors.
Methods of Valuation for Mergers and Acquisitions
The first is the scope of mandate by which the special committee can retain and direct financial advisers throughout the deal process. The second is a documented, high level of engagement between members of the special committee and the financial advisers, both as it pertains to deal process and valuation analysis. Thornton: An independent special committee will bring an independent impartial view and will often be supported by its own advisers.
Where there are potential conflicts for the directors or issues such as connected parties, a committee has a valuable role to ensure the transaction is fair to the different stakeholders. What trends should dealmakers be keeping an eye on? Thornton: General expectations are that dealmaking will remain robust. The value of business can be approached using three different values: 1.
Going Concern Value: This value concentrates on the earning potential of business entity. It assumes that the business is a perpetual entity which is separate from that of its promoters and will not be affected by such external events. Liquidation Value: This value represents the amount received on selling off all the assets and settling liabilities. Some important assets in such method which should be calculated appropriately are intangible assets such as goodwill, brand value, etc.
This method helps set a benchmark below which the business should not be valued, as the same will not yield any gain for shareholders. Market Value: This relates to listed companies. It is the price at which the company is trading at a recognized stock exchange. An important thing to understand under this approach is that the 'price' of security trading on stock exchange cannot give the full picture of its fundamentals and their potential.
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This price generally represents more of markets sentiment and not actual state of a business. Elaborating on the aforesaid approaches, three different methods to business valuation are enumerated below. Either or a combination of the following methods are followed based on the purpose or objective of valuation - sale or purchase of business, merger, acquisitions, IPO , funding, financial reporting etc.
Asset based valuation In this approach, the value of a business is calculated based on the book value of its net assets. It is a preferable valuation method for investment or real-estate companies or where the business is required to be re-invented or re-structured by a company. Fair market value of assets is reached to get enterprise value. To get fair value, adjustments for inventory undervaluation, patents, goodwill, bad debts, etc.
After accumulating net fixed assets, investments, current assets, intangible assets and deducting short and long term liabilities, the amount available to equity shareholders is reached.
Earning based valuation Business value under this approach is based on the present value of future cash flows of one's business. Future earnings of the business are estimated by making adjustments for extraordinary items such as seasonal fluctuations. The key element all investors look after is earnings. Before investing in a company they want to know how much the company is making in profits.
Future earnings are a key factor as the prospects of the company's business and potential growth opportunities are determinants of its stock price. Factors determining earnings of the company are sales, costs, assets and liabilities. The common valuation model used under this valuation is Discounted Cash Flow Method.
Equity valuation models can derive either absolute or relative values. Market based valuation Market valuation or Relative equity valuation models estimate a stock's value relative to another stock and relies on the use of multiples. A multiple is a ratio between two financial variables.
In most cases, the numerator of the multiple is either the company's market price in the case of price multiples or its enterprise value in the case of enterprise value multiples. The enterprise value of a company is typically defined as the market value of its capital debt and equity , net of cash. The denominator of the multiple is an accounting metric, such as the company's earnings, sales, or book value.
Multiples can be calculated from per-share amounts market price per share, earnings per share, sales per share, or book value per share or total amounts. Some of the common price multiples used under this valuation method are: 1.
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