In a recent post, I shared some tips for making a business acquisition work successfully and therefore to realize its full value. Of course before you can do that, you have to make the acquisition, which involves an estimation of the target company’s value. In this post, I share some knowledge that will help you to successfully conduct a company valuation and ensure your bid represents an accurate estimate of the target’s worth. But first, you should know some of the most important tenets of valuation when making a business acquisition.
There Is No Right Way to Conduct a Company Valuation
While there are a number of important principles in assessing the value of a business acquisition, the whole business is far from being an exact science. A company that is for sale or even one that is not will be worth more to one potential acquirer than to another. A lot may depend for example, upon the expected value of synergies achieved through the acquisition.
However, there are some general aspects of company valuation which should always play a part in the process. These are the important things which I can help you to understand and which will go a long way towards making a realistic evaluation of a target company’s worth.
If You Want to Keep it Simple, Use EBITDA
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. In other words, it’s the amount of income that a business generates annually. The closest thing to a de facto standard for a company valuation is to multiply the EBITDA figure by five (5 x EBITDA).
Therefore if the target of your business acquisition plans has an annual EBITDA of $1 million, you might consider its acquisition value to be $5 million. Depending on the state of the economy at the time you consider your acquisition, you may decide to amend the multiplication factor to 6X in good times or down to 4X if the fiscal climate is not so favorable.
Again though, even if you follow this format, your company valuation will depend partly on your reason for acquisition. If you are expecting to secure strong, rapid growth for your target company, you might be prepared to offer a considerably higher multiple of EBITDA. This method of company valuation is based on the earnings of the concern you plan to acquire, but you can also calculate a valuation based on assets.
If you were starting a whole new company from scratch, you would have to purchase all the inventory and equipment needed to run it. Therefore, you can evaluate an acquisition by calculating the value of all the inventory and equipment that it owns, which will of course become yours after the business acquisition is completed.
The target company’s balance sheet should provide all the information you need for this type of valuation and if it doesn’t, you should probably not make the acquisition—bad bookkeeping is a definite red flag when it comes to any business acquisition.
In some companies, the value of their non-tangible assets can be pretty steeply valued. For instance, a path-breaking algorithm or a state-of-the-art code or software may tilt the value to millions. This is where you may need a good Intellectual Property advisor and valuator, who will break down the asset valuation for you and you can make an educated decision.
Another form of asset-based company valuation is the “liquidation value”. This is the calculated value of the target company after all assets have been sold and taxes and debts have been paid up. The liquidation value of a company will typically be a lot less than the value that would be placed on the company if it was put up for sale in the commercial property market.
Further Considerations for a Company Valuation
In an article like this one, it’s not possible to delve deeply into all the complexities of conducting a company valuation. Hence necessity dictates that the methodologies discussed so far comprise crude examples to give you an idea of what’s involved.
Unless you are skilled in the art of valuation – in which case you won’t profit from reading this blog post – the best advice of all is to enlist the help of a professional business valuator, who can investigate your target company and provide you with an unbiased, comprehensive valuation. Whether you take this advice or not, it’s still worth gaining an awareness of some of the other factors and considerations to be taken into account when evaluating a business acquisition.
Projected revenue growth: While EBITDA multiplication can give you a valuation based on your target business’ earnings today, it’s more realistic to consider whether these are likely to remain the same in the future. Generally it’s a good idea to perform your valuation with some expectation of revenue growth—but don’t overegg it.
Risk associated with the business: You should certainly factor risk into your company valuation. For example, does the target company have a problem with high employee turnover or does it have a solid and loyal workforce? Is it a company known for the quality of its products or services, or has it been subject to complaints of falling standards? Questions like these are highly important and will certainly be covered by a professional business valuator.
And Finally: The Non-financial Elements of Company Valuation
Ultimately, there may be many, many factors involved in your calculation of what a business acquisition is worth. It would be unwise for me to pretend that company valuation is in any way a subjective exercise. What it boils down to, is “what is the target worth to you and your existing business?”
Engaging professional help is a good way to make the process more objective, but a valuator will not be able to tell you if absorbing or merging with a target company will add that “special something”, making the union more valuable than the sum of its parts—that part is up to you to assess. Hopefully though, some of the tips here will demystify the valuation process and help you to prioritize the way in which you base your bid-price calculation.