The Importance of Business Valuation

Introduction

By definition, valuation work cannot be considered a precise science, and the findings reached in many circumstances will be subjective and based on the exercise of individual judgement. As a result, two distinct (and highly competent) valuation practitioners may arrive at different conclusions.

Financial reporting (for example, impairment evaluation, purchase price allocation, and share options), tax, project finance, dispute/ lawsuit, investment appraisal, restructuring, and other regulatory requirements may generate demand for valuation services.

There are several significant elements when it comes to valuation work, and they are essential when completing any valuation job:

1. Valuation Subject - Identifying value drivers, company risks, and economic rates, if applicable.
2. Dates of valuation
3. Basis - Fair market value, accounting or legal value, economic value, and value in usage
4. Stakeholders
5. Specialized Knowledge
6. Information readily available
7. Approach to Valuation - Income, Market Value, and Cost

The following discussion topics are meant to offer you a basic understanding of why valuation is important and how tiny details might affect the final outcome.

1. Price vs. Value

Price may not always imply value.

The price is established once the asset is placed on the open market for sale.

Value is assessed in the context of a hypothetical market at a specific point in time (current or historical). So, you may wonder, why do price and value differ? This is because values do not always account for the individual circumstances of the buyer and seller (i.e. the operating and finance synergies, information availability, funds available for purchase, participant specific motivation).

Affordability (does the purchaser have enough cash and can they receive financing for the acquisition?) and seller specific considerations such as whether or not the seller is in a hurry to sell may all impact price (i.e. forced sale). Value, on the other hand, refers to what it is genuinely worth to the buyer or seller after taking into account the aforementioned factors (i.e. synergies and information availability, etc.) In terms of synergies, a real-world example would be the acquirer's willingness to pay a premium for predicted cost synergies (i.e. a leaner organization) or expected revenue synergies (i.e. increased market size) following the purchase.

The purchaser will not give away all of their planned synergies throughout the merger and acquisition negotiation process, and the competitiveness of the bid may also impact the price. This explains why two distinct valuation practitioners might arrive at two different findings, i.e. the buy-side (sell-side) advisers arriving at a lower value (higher value).

 2. Enterprise vs. Equity valuation

The net asset value is the value immediately attributable to the shareholders or owners of equity.

Enterprise value is the total of all security holders' claims, including debt holders, preferred shareholders, minority shareholders, ordinary stock holders, and others. To put it another way, enterprise value is the sum of an entity's sources of financing (net debt + equity value) (i.e. net working capital, fixed assets and other assets, etc.)

Accounting-wise, equity value is equity, while enterprise value is asset (i.e., equity Plus liabilities). That is all.

3. Value level

From top to bottom, the level of value:

Strategic Controlling Basis >Financial controlling basis > Marketable minority basis > Non-marketable minority basis

Strategic controlling basis, as the name implies, is the value of an entity from which strategic decisions may be made. It is the highest level. This is similar to the income approach (using discounted future cash flow) or the market approach (using the guideline transaction method)

Simply expressed, financial controlling basis is the worth of when an organization achieves more than 50% of the shares and may exercise control (technically speaking it is when certain party has the power to control, according to the accounting standard). It is ranked second on the list.

Marketable minority basis is the worth of a marketable entity that is on a minority basis (think of equities that you may easily transfer in an open market such as a stock exchange) (i.e. again think of the stocks you held it is usually an ant-size relative to the entire share cap). This is linked to the market approach (using the comparable quoted company multiples)

Non-marketable minority basis is the worth of a 'private' company where one must actively seek market players to trade (concerning transaction liquidity) and is on a minority basis (i.e. excel no control / major effect on the business).

The control premium, discount for lack of control, and discount for lack of marketability are the things that bridge the four bases, and they are mainly up to expert judgement.

4. Approaches to valuation – in a nutshell

Most people are interested in understanding the "real value" of stocks they want to buy. The video in the link below is a very interesting take on the subject.

https://youtu.be/WMdnaRQ4EOE

That's all for now …