When thinking about selling a business, it is important to realize that the value of the business is an important consideration for any business owner. Getting to grips with the company valuation process and how the business may be valued by potential buyers ensures that business owners can appropriately evaluate offers and determine whether such offers represent fair value. A sensible, rational company valuation will estimate what can be realistically obtained, allowing for the business owner to prepare for any negotiations that occur as part of the sale process.
Buyers can use several approaches when valuing businesses for potential acquisition:
- Discounted cash flow (DCF);
- Multiple based valuations (MBV);
- Replacement cost or liquidation value approach.
Discounted Cash Flow
A commonly used approach for company valuation is the DCF valuation methodology. This considers any money the business can expect to generate in the future and the risk associated with such cash flows. These future cash flows are essentially discounted back to their ‘current’ value using a rate that reflects the risks associated with future earnings and business cash flow, discounting the future cash flows.
The business is valued as a standalone entity and any non-business expenses of the current owners are taken out of the equation. Any items, such as historical once-off pots of money, not expected to be repeated in the future do not feature in this forecast. Practically speaking, current budgets and future forecasts are used as a great starting point when determining future cash flows.
What discount rate is used can significantly change a company valuation. Often, the weighted average cost of capital (WACC) method is used by corporates for investment decisions. This method represents the rate of return that, at a minimum, investments made by the corporate should achieve.
The discount rate can also be seen as an opportunity cost; what return on investment could be expected for investment alternatives with similar risk profiles? The return on investment for an investment of comparable size and risk is the opportunity cost and, hence, the discount rate for the DCF valuation. A DCF valuation can be complicated and changes, even small ones, in certain input variables can significantly impact the end result.
Multiples Based Valuation
A MBV is often used to support a company valuation obtained by DCF. A common approach is to apply an appropriate multiplier to the earnings before interest, tax, depreciation and amortisation (EBITDA), which gives the enterprise value of the business (EV). The EV is then normalised for the net business debt to calculate the business equity value. Several factors must be considered when determining what valuation multiplier to be used:
- Size: listed businesses are generally larger with a more diverse product portfolio and income stream, suggesting a lower risk profile. This results in a greater multiplier needed;
- Quality of earnings: businesses with high-quality earnings and good prospects will need a higher valuation multiple than businesses with lower quality earnings and bad prospects;
- Control premium: where a purchaser acquires a controlling share of a business, the valuation multiple will include reflect the value of obtaining control of the business during acquisition.
Replacement Cost / Liquidation Value Approach
During the acquisition of a business with unique or specialised machinery, the buyer may also consider the cost of replacing the cost of the plant, equipment and/or property to support other company valuation approaches. This method rarely forms the primary company valuation method.
Food and beverage business owners with already existing businesses could benefit from synergies in cost or revenue when they combine both acquired and currently owned business. These benefits include access to new customers for cross-selling, increased purchasing power over raw materials or a reduction in employee numbers. When performing a company valuation, potential buyers should first determine a standalone valuation of the potential acquisition. The buyer will then calculate the current value of expected benefits, such as those described above, that will come from acquiring the target.
The total sum derived from the standalone business value and the value of any synergy benefits represents the maximum value possible from an acquisition. Buyers usually do not want to pay more than the standalone value of the business. That said, in a competitive situation, it may be that buyers are required to share at least part of the synergy benefits with the seller in order to complete the acquisition.
It is therefore in the best interest of a business owner to highlight any potential synergy benefits when interacting with potential business buyers. An external adviser may assist with this process; an Information Memorandum that is tailored to specific industry players is a great tool to outline the potential opportunities to create value.
Speak to one of our consultants for a comprehensive review of your business today.