Sophy Buckley looks at the different ways to value a company for a buyer, a seller, or even an investor
“Beware the buyer’s curse. In almost every case, the buyer is the party who bid the most. After the euphoria of success has died down, this can leave you wondering if you overpaid and if so by how much,” warns Henry Flint, finance director at Katana Property, who has bought and sold companies for many years.
Whether buying, selling or investing in a company, everyone wants to get the best price. For the seller, that means the highest price, for the buyer or investor it’s the lowest. But how do you value what is often a unique asset?
There are various text book methodologies – net assets, price earnings ratio, discounted cashflow to name just three, but in reality it never comes down to one method. The price of an asset is only what someone is prepared to pay and motive will always influence this. For a buyer, is it a rare asset, will the deal reduce competition, plug a whole in their offer, bring new know-how or cut costs? Equally, a seller’s motives will have an impact on the price he is prepared to accept – perhaps the sale is distressed, due to retirement, opportunistic or a planned exit. Opening up a relationship with the other party will help you uncover the other party’s motive, says Henry, and will help both sides put a realistic value on the asset.
Tony Gibbens, senior private banker at Coutts, thinks the type of person buying the asset can also have an impact on valuation. “Visionaries and entrepreneurs get excited by ideas not net profit margins,” he says. On the other hand, angel investors tend to be very numbers focused. “They often have their own way of valuing a company but it will be brutally criteria-based. If a business doesn’t match up, it doesn’t stand a chance,” he says.
For sellers, Tony believes preparation will secure the best price. “Produce packs with all the historic financial data, a market narrative and a clear focus on the business’s potential. It might also be worth hiring someone to help sell. They will have experience, contacts, know the market, and will use all that to start an auction. They will charge a fee but it will be worth it as they can help push up the price,” he says.
Henry agrees and adds that the ground work should ideally be laid years in advance. “Sometimes it’s worth starting two or three years beforehand. Make sure the books are up to date, install proper financial controls, maybe beef up the board with some non-exec directors and get any extra family off the payroll. Make the business simple for a buyer to understand when they do due diligence,” he says. He also suggests considering having an independent firm of accountants perform vendor’s due diligence as this can throw up potential problems and help establish realistic goals.
Right at the start of the process, Henry says, it’s key for the seller or sellers to decide an acceptable outcome - i.e. the floor price. “From start to finish can be gruelling and so when you’re really close, burning the midnight oil, everyone’s tired and the buyer starts to chip the price, if it is still within the original target, go ahead. Don’t let emotions kill the deal,” he says.
To get the right price when selling a company, Henry prefers a valuation based on discounted cashflow –looking at future cashflows adjusted over time; the further out in time, the higher the risk that the cashflow will dry up. When buying a company he checks the profit and loss accounts over time, creates a five to 10 year forecast and comes up with an internal rate of return. “If the numbers don’t add up, you must walk away,” he says.
Other common valuation methods include multiples of turnover, but Tony cautions against this. “There’s a great saying: turnover is vanity, profit is sanity. I’d rather look at a company with a lower turnover and good profitability,” he says. Nor is he currently keen on price earnings ratio (used in publicly listed companies where value is calculated by looking at the earnings achieved for each share at a price on a given date). “Ratios are quite low at the moment – often less than 10 but that doesn’t mean they won’t go lower. We know the price today but we don’t know the earnings tomorrow,” he reasons.
Indeed, the unknown always seems to be the fly in the ointment. For the buyer, we return to the initial dilemma, and equally the seller may never know how high the buyer was prepared to go. But reaching a mutually agreeable price is possible if buyers and sellers take good advice and are prepared to compromise.
By Sophy Buckley
