All banks and most private equity firms, along with publicly traded firms, need a valuation done on a prospective seller for financing purposes.
There’s no getting around this—it’s nonnegotiable.
As a normal part of our M&A work, we provide a calculation of value for both buyers and sellers as the project goes along.
Here’s how a valuation works as part of the M&A process, and why it’s SO critically important in the process of selling your firm or acquiring another one.
There are two types of valuations: Calculations of Value and Conclusions of Value.
Calculations are great for M&A and internal purposes to understand the value of a firm, and to begin to frame up the deal structure for a transaction between a willing buyer and a willing seller. Conclusions carry legal liability by the valuator and are predominately geared to litigation and IRS proceedings, where there is no willing buyer and the court must determine a share price in lieu of one.
Start with Calculation of Value
When doing buy-side representation, we start with a calculation of value for the buyer and then complete a calculation of value for each selling prospect in preparation for a letter of intent.
This helps us to determine two things:
- The financial synergies between your firm and another firm.
- The foundation for quantifying strategic synergies.
Most buyers do not realize that in doing a transaction (aside from any synergies) there is a 10% to 15% increase in value simply in becoming a larger firm. With any level of synergy and consolidation, most firms will see a 25% increase in the converged value.
When representing sellers, we start with the calculation of value to begin to shape the value paradigm in preparation for a transaction.
There is significant confusion in the technology marketplace as to the key differences between industry multiples reported about transactions and valuations.
In addition, there is a plethora of companies that look at real transactions and report crazy multiples and overinflated EBITDA, or some other benchmark. Their reports aggregate data across an industry or industry segments to provide averages, showing industry and marketplace dynamics. These data points cannot determine the value of your business, however.
Why? There are literally hundreds of things that come together to determine value.
I can’t list all of them here, but a valuation comprises economic indicators, market and financials previously mentioned, the specific risks of the company as it pertains to market position, sales pipelines, product and services offerings, competitive factors, client relationships, quality of income, intellectual property, employee loyalty, vendors, all the agreements, management quality, and more.
While these valuation points aren’t sexy, they’re necessary for a healthy transaction to take place so you don’t end up losing money or being negatively impacted in other ways.
Misunderstood Aspects about Valuations
One of the most misunderstood aspects about valuations is that they are built around a hypothetical buyer.
I’m going to get technical but not too boring … keep reading. The “premise of value” (key words for the valuator) has to do with why the valuation is being done and a profile of the hypothetical buyer is built upon that premise. What valuations rarely deal with are the specific synergies of a known buyer. You see, a valuation or calculation of value is an academic exercise that produces an expectation around value, but the actual value in a transaction will always be determined between a willing buyer and a willing seller at a specific point in time.