Business valuations are often described as ‘part art, part science’ or even ‘a dark art’. In the realm of mergers and acquisitions (M&A), valuation is the…
As part of our corporate finance team at PKF Francis Clark that specialise in company valuations, I often have clients ask difficult and challenging questions on the topic. I also find going back to basics helps to get to the answer.
1. The different types of value
There are four different types of valuation: market value, fair value, equitable value and tax value. The key is to be clear about the requirements at the onset of a valuation assignment.
2. The value of an asset
The value of an asset is the value of the future cash flows that derive from ownership of that asset. It is helpful in understanding the logic on “why?”
- Different buyers may place a different value on company
- The application of a dividend-based valuation model may be appropriate for valuing a minority shareholder in a company that pays regular dividends
3. Value is not the same as price
Negotiations on a company sale often bring relative bargaining power to the fore. This is one reason why, in most cases, value is not the same as price.
4. There is no right answer
It is important to remember that, on a number of issues, between buyers and sellers there is no right answer but there is a compromise that can be reached.
5. Valuations are subjective, but…
Whilst there is no doubt that valuations can be subjective, there are rules to valuations. When we get valuations or aspects of valuations to review, the easiest valuations to challenge are those that stray from the understood norms. For example that enterprise value is cash-free and debt-free, assuming a normalised level of working capital – more of which below.
Ultimately, valuation methodology is both theoretical but also undertaken in real world transactions and any theoretical valuation must follow those real world principles.
6. Enterprise value can be restated
Enterprise value is usually based on multiple profits. Whilst enterprise value is often described as cash free, debt free, etc., it is often useful to recognise that it is the value of the trade.
Enterprise value includes the fixed assets needed to generate the profits, a normalised level of working capital, and the intangible business know-how. Remembering this can often cut short deliberations on which balance sheet items to adjust for.
7. Cash free, debt free
Increasingly, we are seeing sales agents misusing “cash free, debt free” – particularly in property-based company transactions. Here, it would be the norm for adjustments on a property’s value for most other balance sheet captions in arriving at a value for the company itself.
Debt and normalised working capital are often contentious, especially in the transactional setting. To avoid confusion, we recommend including illustrative examples of the derivation of company value in the Heads of Terms.
8. Valuations and tax often intertwine
Three things to keep in mind are:
- In a transaction, sellers need to be mindful that a post-tax value is important to them
- Treat corporation tax as debt
- Reports prepared for HMRC need to consider information standards, disclosure and HMRC expectations/areas for potential challenge
PKF Francis Clark
Our valuation reports are logically constructed. We can talk the client through the various aspects in a way that makes most sense to them. We are increasingly asked to prepare valuation reports as part of a company’s strategic development, be that:
- Part of the Options Review on exit planning; or
- Benchmarking and identification of value drivers for future developments of the business
If you would like to speak to us about valuations then please get in contact with a member of the team.