“How much is my business worth?” :
a question that every company director must have asked himself. Particularly when you’re planning to sell your business or attract investors.
As an investor or buyer, you may also ask yourself:
“How much is the company I want to buy or invest in worth?
AKCEAN guides you through this delicate operation, so that you can benefit from the most accurate valuation possible, applying the methodologies best suited to your needs. Negotiate serenely by estimating the value of your company before the transaction.
What is business valuation and when is it necessary?
Crucial to many transactions and decisions, valuation represents an estimate of a company’s financial value at a given point in time. This calculation is based on the company’s accounting data, but also takes into account its future prospects.
As a manager, you may need to initiate a valuation for a variety of reasons:
- a sale ;
- an acquisition or merger
- the arrival or departure of a partner;
- a request for financing;
- succession planning;
- an initial public offering (…)
Valuation enables you to establish a so-called “theoretical” value. That’s why it’s so important when it comes to negotiations. It enables you to understand what the company is worth, so as to guide the negotiation process. The challenge lies in the choice of method to be applied, which depends primarily on the company’s situation and the objective or context of the valuation. This is why there are different valuation methods, more or less adapted to the company’s size, business sector, assets or life cycle.
What are the main valuation methods?
1. Comparable method
The comparables method, commonly used for established companies, enables you to determine the company’s financial value at a date “t” by comparison with the value of other companies. The comparables method is, as the name suggests, based on a comparison of the company being valued with other similar companies operating in the same industry and with similar growth prospects. The company’s value is determined by applying a multiple to a specific accounting or financial indicator, such as sales or profitability.
The method involves determining a series of multiples based on data from companies whose valuations are known and comparable. These multiples are generally known because the comparable companies are listed on the stock exchange or have already been the subject of a transaction, the terms of which have been made public.
The comparable method can be summarized in 3 main steps :
- Selecting your sample of comparable companies: the most similar companies in terms of activity, size and geography must be selected to ensure the relevance of the multiples used.
- Choice of multiples: companies are frequently valued using the enterprise value (market value of shareholders’ equity, financial debt and debt) in relation to EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), an indicator of operating profitability. The Enterprise Value/EBITDA multiple is thus commonly used, but other multiples based on sales, operating income, net income or cash flows may be preferred, depending on the company’s sector of activity and financial situation.
- Applying multiples to value your company: the multiple observed for comparable companies is applied to your company’s performance (EBITDA, sales, etc.) to determine its valuation.
Advantages and limitations :
This valuation method does not require a business plan, and is relatively simple to understand and apply. In some cases, however, it is difficult to select companies that are sufficiently similar to the one being valued, and price information on transactions is limited.
2. Discounted Cash-Flow (DCF) – Forward-looking method
The Discounted Cash-Flow (DCF) method consists in determining the financial value of a company at a date “t” through the cash flows it will generate in the future, discounted to a present value.
It can be used as part of a fund-raising or M&A process. Internally, this method can also be used to determine the relevance and interest of a potential investment. In order to add up all future cash flows, discounting is used to reduce them to their real value at the same date. Discounting is necessary because €100 today will not be worth €100 in 1 or 10 years’ time. Similarly, €100 in 1 year’s time will not be worth €100 today. This valuation method requires a solid business plan and an estimate of expected cash flows over the next few years. These are then discounted at the expected rate of return, with each cash flow weighted in decreasing order over time.
This method is called “intrinsic”, as it is based on the company’s ability to generate cash flows. It is therefore particularly relevant for companies with specific features that require the modeling of particular growth, profitability and investment forecasts. This is the case, for example, for start-ups or companies considering changes to their business models.
The DCF method can be summarized in 4 main steps:
- Identification of free cash flows (cash flows generated by the company)
- Evaluation of the discount rate (Weighted Average Cost of Capital, the rate of return expected by all providers of capital)
- Choice of forecast duration (business plan horizon)
- Calculation of terminal value (value of the last cash flow of the business plan period, assumed to grow to infinity)
Advantages and limitations
The DCF method has the advantage of forcing the entrepreneur to project into the future, and requires a robust business plan. However, future cash flows are uncertain, as it is difficult to predict the future, and valuation is highly sensitive to the discount rate used.
3. Net Asset Value – Patrimonial method
Net asset value, also known as the patrimonial method, is calculated from a company’s balance sheet. Assets and liabilities are valued at their market value, making it possible to determine the market value of shareholders’ equity.
This method is preferred for companies whose value is based essentially on their assets, such as holding and real estate companies.
The valuation of each balance sheet item is essential, as book values do not necessarily reflect the true value of an asset or liability. This is why it is necessary to re-evaluate asset data and determine, on the basis of their market value, the value of the elements that make up the assets and liabilities. This amounts to considering the company as a superposition of assets and liabilities whose value is defined independently. The principle is to value each asset precisely.
The patrimonial method can be summarized in 3 main steps:
- Identify and precisely list all the elements that make up the company’s assets and liabilities, including off-balance sheet commitments
- Determine the market value of each of these elements
- Determine revalued net assets, which represent the market value of shareholders’ equity, by deducting revalued liabilities from revalued assets.
Advantages and limitations
The calculation method is readily available, provided there is a consensus on the valuation of the elements that make up the assets and liabilities. However, the company’s economic potential is not taken into account in the value calculation.
The value of a company remains a theoretical value and may differ from its price. The estimate may also vary according to the valuation methods used. What’s more, each of these methods has its own advantages and limitations. It is essential to choose a method that is adapted to the characteristics of the company being valued, to the valuation objectives, and to take account of market conditions at the time of valuation.
Last update: September 2023
