Your Business: What's it Worth?

Valuations - Your Business: What's it Worth?

Heather Stevenson, KPMG Corporate Finance Partner focusing on valuations, discusses why you need to get behind the numbers when valuing a business - particularly given the challenges of valuing companies in the current difficult economic conditions.

Any valuation is all about future cash flows.  This earnings stream is, after all, what a purchaser of a business is paying for.   The financial projections are the basis for most valuations but running sensitivity and scenario analysis around a range of discount rates and growth assumptions will not be sufficient to achieving a commercial and robust valuation.

A valuer must get to know the business - ideally by leaving the computer in the office and going out to the company and talking to management.

To be able to evaluate the future cash flows, a valuer must have a full understanding of:

  • the business being valued;
  • its  market; and
  • the dynamics surrounding the valuation.

Getting to know the business
The first step in any valuation is to get to know the business so that the valuer can properly assess the quality of the cash flows and risk.

Key questions will include:

  • Product / Service
    How unique is the product or service offered by the business?  Are there any significant barriers to entry e.g. through patents, technology, brand? What is the scope for extending the range or expanding geographically?
  • Customers
    Who are the key customers? Is there an over reliance on a small number of key customers representing a potential risk to future earnings?  Conversely a diverse, well spread number of loyal customers implies a better quality earnings stream.  Key topical issues include checking the financial position of key customers and how the customers are being impacted by recession.
  • Suppliers
    How secure is the company's supply chain? Again the financial viability of key suppliers is a key question in current times. What are the alternatives should a key supplier go out of business?
  • Management
    How strong is the management team?  An experienced motivated management team is an important plus that will enhance the value of any business - but not if they are due to retire imminently.?

It is the answers to these type of questions that will enable the valuer to get a deep understanding of the business being valued.

Understanding the market environment
No business operates in isolation and it is therefore critically important to assess the market environment into which the business is selling.  How does the business rank against its competitors? How big is its market share and what are the opportunities for increasing this? Is there a key competitor likely to go out of business in the near future and how well placed is the company to get the custom?

Market growth expectations and competitor information also provide useful data to test the reasonableness of a business's cash flow forecasts.

  • What are the dynamics?
    In any valuation, it is important to consider carefully the purpose of the valuation and the circumstances in which the valuation is taking place.  Depending on the basis of valuation, the following may have a material impact on value:
  • Dynamics of the seller
    How badly does the seller need to sell?  If the seller needs to liquidate investments quickly, they're unlikely to get a good price.
  • Dynamics of the purchaser
    Competing buyers each with strategic interest in getting market share for themselves and as importantly, stopping their number one rival getting that market share will push up the price in negotiation.
  • Who is interested in buying the business?
    A purchaser may be interested but do they have the funding? Will there be any competition issues which may rule out a potential purchaser?
  • Going concern issues
    What is the business's debt position and working capital and capex needs? Have there been or are there expected to be any covenant breaches?

In conclusion, only when the valuer has achieved a proper understanding of the business, market and dynamics information, should he or she start running discounted cash flow analysis and applying multiples to earnings.  This is essential to assessing the quality of the cash flows and the risk and therefore the required return of an investor leading to producing a robust and fair valuation opinion.

 

Contact

If you are interested in hearing more or would like to know about how we can help your business, then please do contact Heather Stevenson on 020 7311 8578.