Significance of Valuation in Strategic Corporate Actions

Valuation of a business or company unit is the process of determining the current worth of a business, using objective measures and evaluating all aspects of assets. In the current dynamic business ecosystem, the fair value of a business is essential for establishing partner ownership, taxation, litigation, buyouts, real estate property or gift taxation and even divorce proceedings. Financial market players use valuation methods when buying or selling a business including business reorganizations, expropriations, employee share or stock option plans, mergers and acquisitions (M&A) and shareholder disputes.

Merger is the combining of two businesses, while an acquisition is the purchase of ownership of one company by another. M&A is primarily preferred to get inorganic growth and synergy, the potential value gain from combining two firms, either from operational or financial resources. The large company wish to acquire small progressive company has a substantial competitive advantage such as innovative technology,unique product or service that protects the acquisition from future competitive upshots. Valuation is done to evaluate fair value of such a stock when a company goes for Initial public offering.It is imperative to analyze the financial profile of two combined companies to figure out whether the buyer’s earnings per share will increase or decrease on merger.

Valuation is necessary involves reporting the company’s assets and liabilities to identify tangible and intangible assets, transfer of equity between partners or shareholders and business appraisal before obtaining a loan which is greatly influenced by prevailing market conditions. Changes in valuation may occur due to certain types of company being in high demand with brand value.

The company or business valuation process is generally includes an analysis of the company's management, capital structure, market value of assets and future earnings prospects. The review of financial statements, discounting cash flow models and similar company comparisons are some of the commonly use valuation approaches used in financial sector. The company assets intrinsic value is worked out by considering current market or replacement value of assets. Properly presentation of strategic value to right investor has the potential to significantly raise valuation during transaction process.

Synergy can be achieved via increased revenue, pooling of talent, resources or technology, streamlining of operations and via cost reduction initiatives. The brand value can be calculate by different methods and the brand equity is one of the few assets in business that can provide a sustainable competitive advantage.

SWOT analysis is an integral part of the valuation process which is the pinnacle of risk assessment process and is based on an analysis of a company's qualitative characteristics, historical operating results, national and local economic trends that directly impact the company. Analysis of critical factors provides an understanding of the company's overall risk profile and facilitates the determination of an appropriate rate of return for an investment in the business and the selection of relevant market multiples.

The valuation process is highly technical & sensitive so the valuator should be competent to have financial  knowledge, aware of the company’s business model, strategy with the deep understanding financial market and value creating elements.

Different methods of valuation to establish pricing are being used depending on the objective of the assessment, future earnings, industry or sector, size of company, objective, expected cash flow and the type of company, product or service. Each valuation method naturally has its own set of advantages and disadvantages, so the methods to be adopted for a particular case of valuation must be select judiciously. The valuation comparables is very important in investment banking however multiple methods of professional valuation practiced to understand the intrinsic value of a business. The commonly used business valuation methods are asset based approaches, earning value approaches and market value approaches.

Asset valuation is usually conducted before selling or purchasing an asset based on various factors, including transaction value, cash flow or comparable valuation metrics suitable to make a clear distinction between the assets of the company and its owners to estimate the value of a business. It is basically consider fair market value of the assets less the fair market value of the liabilities of a company. The appraiser count all the cash, stocks, inventory, machinery and equipment, real estate, vehicles, office furniture and fixtures, land and inventory, the value of intangibles like patents and customer lists should also be included. The asset approach include tangible assets value with liabilities and excludes company’s goodwill or value for intangible assets so the asset approach is best used for companies that are asset intensive or lack a history in earnings.

The adjusted book value method is one of the basic means for valuing a business and its assets takes into account the depreciation of assets over the time and what remains on the business books to understand the tax liability with business worth.

The adjusted present value method to assess corporate value and utilizes adjusted cash flows represent core value in case of high debt, tax rates changes, consistent operating losses and changing capital structure. The analysis of historical and future performance helps in determining the value of the seller's business to the buyer and such methods include Return on Investment, Internal Rate of Return and Net Present Value.

The Earning approach is basically to evaluate actual value of a business lies in the ability by capitalizing past earnings to produce revenue in the future by analyzing current cash flow, annual rate of return and the expected value of the business. Capitalization of earnings is determined by calculating the Net present value of the expected future cash flows or profits.

The Net Present Value method takes into account the weighted average cost of the company’s capital with all assets listed on the balance sheet and assume predictable and compatible capital structure and tax rates into the future. The financial obligations have to be deducted from the gross asset value to obtain the net asset value.

Net Assets is the simplest form of an assets based valuation requires adding up all of the company’s assets and subtracting all liabilities but this method does not take in to account of the company's future earnings prospects. The P/E ratio basis of valuation is one of the best approach under favorable conditions. The P/E ratio of a company is the value of a company divided by its after tax profit. Net Present Value is generally the most preferred financial-performance indicator used by appraisers in a pre-acquisition valuation also use to compares with the present value of the proposed transaction's benefits, costs and other impacts.

The explicit equity value per share or share price can be evaluate by direct valuation methods. Earning value approaches is one of the most common types of valuation method based on the business ultimate value and ability to produce future wealth and capitalizing past earning. The earning value are based on the premise that the current value of any business an investor can expect to receive from purchasing all or part of the business and involves looking at an organization’s financial history to make projections about their future profits.

The discounted cash flow model is one of the prominent and common valuation methods used under feasible conditions based on the net present value of a company, brings all future free cash flows back to the system. The company asset value compare with other parallel company's value in the same industry by using valuation multiples. The discounting of expected future cash flows is considered one of the best methods for determining the project value, crack investment or the payback of a acquisition opportunity. It uses the expected future cash flows and discounting them by the weighted-average-cost of capital for the industry mainly facilitated through debt and equity offerings by companies. DCF method not influenced by non-economic factors expresses the present value of the business as a function of its future cash earnings capacity. The investment banks advise corporations on mergers & acquisitions (M&A), restructurings, and other major corporate activities.

The revenue multiple method is commonly used to evaluate valuation and capture sentiment about the company. The relative valuation method uses multiples wherein the details of recent transactions of similar business are considered to estimate the business value. The price-to-earnings (P/E) ratio is one of the most popular multiple used in valuation of company. When a firm has high price-to-earnings (P/E) ratio, this means it is trading more profitably than other companies of the same sector.

The critical risk factors for startup valuations:

• Management attitude & approach
• Technology risk
• Statutory & political risk
• Funding/capital raising risk
• Production risk
• Brand reputation risk
• Sales and marketing risk
• Competition risk
• Litigation risk
• Exit Policy

The benchmark for industry multiples including gross profit, operating profit, earnings before interest and taxes, and earnings before interest, taxes, depreciation and amortization. Using previous industry specific transactions data to evaluate business value can be quite helpful. Rules of thumb are dependent on factors profit, P/E ratio or EBITDA. The company's worth factors taking in to account are turnover, customer numbers, number of sales outlets and channel partners as well.

The weighted average method of market prices quoted with the consideration of value and volumes on the stock exchange. The company business appraisals often include different market valuation methods, such as the comparative transaction method and the guideline publicly traded company method require comparison of business to other businesses sold recently in similar industry.

Total Enterprise Value is the gross market value of a company and is substitute with the transaction value. The most common method of determining TEV by taking a financial metric of the company’s annual revenues or EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) and applying a multiple.

Significance of the valuation functions are:

• Business valuation requires relatively basic computation allows you to establish what your venture is worth under present condition.
• The awareness about the value of business or company should be an integral part of the strategic planning process for business owners.
• It provides insight into the key areas of a business allowing owners to leverage on the advantages and focus on reduction in uncertainties.
• Business valuation can consider an analysis of company’s assets, current capital structure and future earnings prospects
• Valuation helps to identify, quantify, and qualify the synergies that increase value to buyers qualify for a loan or financing
• Entrepreneurs looking to sell their company should have an annual assessment of fair market value for their business.
• Multiple shareholders requires a valuation and determine fair market value to buy or sell of company stock.
• The valuation of business also enables management to know how much insurance needed to purchase company stock.
• Gift and estate tax returns are required to include independent third party valuations of all portions of the deceased estate, including any business or business assets.
• Convert companies from one type to another require a valuation at the time of change.
• Valuation helps and guiding factor about decision to continue in the same business, sell, merge, modify or buy other company.
• The value of a company or business used for ratios to measure the total return to all capital holders whereas equity value should be used for ratios to measure earnings and net income.

The business valuation is essential in resolving disputes related to divorce litigation, estate and gift taxation and allocating business purchase price, selling price among assets and identify key elements of business to evaluate the best economic value for future business transactions. The stack holders must be clear about their business requirements, select the right method of valuation with the knowledge about the type of outcome with limitations,  hire experienced knowledgeable professional, availability of correct data and sufficient time to evaluate the most appropriate valuation results to meet the present and future business aspirations.