10 Unknowns of Company Valuations

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The valuation of companies is always a hot topic of interest for owners considering a future exit.

Here are 10 lesser known facts about how companies are valued.

  1. Valuations offered by buyers usually reflect the strategic impact of an acquisition more than the quality of the business itself. This is why buyers are more likely to pay a higher price for an average business that adds to their strategy than for a better managed business that does not.
  2. Sensible private company valuations are based on normalised earnings before interest and taxation (ebita), not on sales, gross profit, profit after tax, or anything else.
  3. When you do the maths, and on a post tax basis, a 5-times-ebita-multiple sale price usually equates to around 10 or more years of dividends.
  4. There is always the potential to gain or lose further exit value in a balance sheet. Good M&A advisors know how to protect balance sheet value (while business brokers tend not to).
  5. From a seller’s perspective, the best earnouts increase price beyond the day-one valuation, other earnouts only secure it.
  6. Private Equity buyers do not think about valuation in terms of multiples. Rather, they work to a target of IRR (internal rate of return), which in simple terms is a function of the amount of cash invested, cash returned upon exit, and the length of time in between.
  7. If a sale is attempted but fails, valuation is reduced by around 10-50% depending on how the sale process and its confidentiality has been managed. This risk and how well it is managed is one reason why not all M&A advisors and their fees are the same.
  8. Predictive valuations are always unreliable. The only way to know an individual business’s value is to market it to a number of buyers and ask for their offers.
  9. Once a business’s profits begin to decline, its valuation decreases at an even faster rate (because both its profits and its achievable valuation multiple are simultaneously reducing).
  10. A valuation is only a true valuation if a deal completes.

 

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