Recently, as a sell-side advisor, I met with advisors of a buyer, hired after a non-binding offer had been signed. They had reviewed all documents shared in the data room and had had a rather extensive brief from their client as to what the objective was and what the main deal terms were.
We discussed at length concerns they had on the business, strategic direction of the company, etc. and then came the question… “we’ve review all the info and prepared our own valuation model but we’re getting a different number for the value of this business. Could you share with us your valuation so we can see how we got to the offered valuation?”
Let’s discuss business valuations a bit here. I believe that entering a transactional process with business valuation done is as important as reviewing with your lawyer all the quirks that need to be rectified before ‘opening the kimono’ or making sure that your books are in order.
On the legal side, this typically means making sure that you’ve filed all that needs to be filed, that your shareholders’ books and minutes are in order, and, to the extent possible, that legal claims are as controlled as can be.
On the accounting side, getting ready usually means that the internal books be reviewed with a comb and any abnormality be rectified or, at the very least, documented. It also means that the ancillary reports must tie to the general ledger and your cost structure be clear and congruent.
However, with respect to a business valuation, there is no right or wrong, no true or false, and no specific rules and guidelines that control how it has to be done or which assumptions to make and how. As a result, if 10 people (or firms) were to conduct a valuation of Acme Company, most likely, ten ranges of value would come out of it.
Assuming all 10 groups were professionals and were acting without bias, those ranges *should* be similar though. However, when a Seller’s advisor and a Buyer’s advisor value a company, Buyer’s and Seller’s advisors will most likely look differently at some of the qualitative assumptions such as growth rate, viability/stability of cost structure, health of the accounts receivable or inventories, capital expenditure required, possible excess liquidity in the business, or other financial considerations.
As a result, on the sell-side, one might put more value in the Discounted Cash Flow showing solid growth in the years to come and, therefore, deriving a higher multiple of today’s earnings whereas, on the buy-side, one might not feel so sure about those projections are prefer to focus on the market value of the balance sheet items or on what others have been paying in comparable transactions.
But even then, questions arise with answers subject to discretionary assumptions. For example, when looking at and valuing the assets of a business, it is fairly straightforward to value say inventories or accounts receivable but what value do you give the brand(s), its distribution channels in place, its customer list and other intangible assets?
OK, so you’re telling us that a business valuation is subjective and biased. So, why is it so important to have it done then?
First of all, yes, most likely there will be discrepancies between a valuation done by a buy-side advisor and a sell-side one but, unless those advisors are wheeler-dealers will little to no knowledge of the industry, both exercises will follow similar processes and assumptions should differ within an acceptable range. Said differently, if sell-side estimates uncollectable receivables to be 10% of the total A/R and on the buy-side a 60% discount is applied, then there are differences of judgement far beyond the valuation exercise that need to be ironed out. It’s a bit as if one side said Deutsch and the other Dutch… Words may sound similar but don’t have at all the same meaning. To continue with that last example, let’s first define whether we’re going to speak German or English, and then let’s talk.
So why is it necessary to do a business valuation? Well, if you’re going to sell your house, you’re probably going to look at what’s in the market right now and what recently sold to get an idea of how much to ask for it. It’s similar here except that it’s a lot harder to get good publicly available comparable transactions. Let’s say you’re in the Pharma sector. Can you really compare your company with Pfizer or GSK? Is it fair to compare your company, generating -say- $30M a year in Sales in 5 therapeutic classes with Endo’s latest purchase, Par Pharma (which sold for $8Bn)?
If your valuation report says your company is worth $70M, it does NOT mean that there is someone out there willing to write a check for that amount. It does however mean that if someone offers you $10M for it, you should decline it as there is a high likelihood that you will get a better offer somewhere else. It also means that if someone comes with an offer of $65M, you should consider it closely as it’s very much so in the range of reasonableness.
Got it. So, how did you reach that Valuation, anyway?
The other thing there’s to know about the ‘true value of a business’ is that there is no better valuation that a firm offer being put on the table.
From the Buyer’s perspective, sometimes, the value is driven by deep and thorough financial analysis. Sometimes it’s 100% by looking at what others are paying for it. Sometimes, it’s achieved looking at how much this asset can be sold for later on. Sometimes, looking at the strategic value that can be driven from this assets is the key determinant (a very simplistic example of this can be: the market is divided between black and white. I sell black and this company sells white. Buying this company double my target market). Most of the time, it’s a combination of these aspects.
From the Seller’s perspective, sometimes it’s a magical number that the owner has had in mind (for example, I have 4 kids and I want to get each one $3M, so my business has to sell for at least $12M). Other times, one sells out of necessity or for estate planning purposes. Sometimes, it is to bring in someone who can accelerate growth, etc.
Finally, there are many occasions where an agreement is reached between Buyer and Seller through a discussion without necessarily much analysis or justification around it.
This was the case in that specific occasion. Buyer asked Seller how much he wanted. Seller said he’s magic number. Buyer offered slightly less, Seller rejected, Buyer up’d the offer to Seller’s price and Seller agreed. That simple! Now it’s up to the newly hired advisors to rationalize that value…
Luckily for them, in Spanish, they have an expression for that – “El Excel lo aguanta todo” – roughly translated as “in Excel, you can make everything work”.