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A Guide to Business Valuations

This article sheds light on the intricacies of business valuations in the M&A arena. By demystifying key concepts, we aim to give you a better understanding of what drives a company’s valuation. From analyzing financial statements to decoding valuation methods, our guide is designed to help you focus on what truly matters when seeking investment or planning for a strategic exit.

Image showing a building and cover text of business valuations

Understanding Business Valuation for M&A Success:

Mergers and acquisitions (M&A) represent a unique opportunity for you to realise a significant return after years of hard work and personal investment in developing a business.

As a founder, you know your business better than anyone and instinctively understand its strengths and potential. However, entrepreneurs often need help identifying or conveying this value to a potential acquirer.

From an acquirer’s perspective, business valuation is part art and part science, with multiple factors impacting the final valuation. An M&A transaction is usually a one-off event, so being fully aware of what drives company valuations is critical to maximizing the valuation from the entrepreneur’s perspective. The first valuation put on the table is seldom the true valuation a business can achieve; driving valuation via a competitive process is the best way to maximize it.

Key Business Valuation Principles Explained:

As a general rule, business valuations are negotiated and finalized based on a single financial metric (e.g., EBITDA or revenue) and a multiple. Key ratios in private M&A are enterprise value/EBITDA and enterprise value/revenue, depending on the profile of the business being valued.

Enterprise value includes both the equity value of the business and the net value of any debt or debt-like items. High-growth businesses with low or no profitability are typically valued with revenue multiples, whereas more established businesses are valued based on EBITDA.

This practical approach is underpinned by the theoretical approach of gauging a business’s future cash flow generation potential, known as the discounted cash flow method (DCF). A DCF estimates the future cash flows of a company and discounts them back to their present value, factoring in the time value of money and the risk profile of the business. Marrying the practical approach of applying a multiple and the theoretical approach of measuring future cash flows ultimately means that buyers and sellers need to find common ground on key quantitative and qualitative factors to strike a deal.

Quantitative Factors in Business Valuation:

  • Historic financial profile: Historic figures are the bedrock for assessing a business’s growth profile, margin structure, and development. Key topics include the quality of revenues (recurring, reoccurring, and one-off revenue lines), margins by business area, and quantifying one-off effects that need to be explained to acquirers.
  • Current trading performance: Presenting current financial year performance can push valuations towards a forward-looking financial metric.
  • Future financial projections: These should be anchored in current business performance and quantifiable future opportunities based on pipeline activities. Key topics include sales pipeline, historic sales performance, and preparations for initiatives to expand margins and match revenue growth with reasonable cost assumptions.
  • Efficiency of capital use: This includes the amount of CAPEX and net working capital needed to grow the business. The balance sheet’s overall health is often used to gauge the potential to fund an acquisition using debt, particularly for private equity investors.
  • Market share development and financial metric comparison to competitors.
  • Synergies with strategic acquirers: These include both revenue and cost synergies.

Essential Qualitative Factors in Business Valuation:

  • Market attractiveness and growth opportunity: If a well-thought-out strategy is presented, potential acquirers may stretch their valuation frameworks in emerging or high-growth markets.
  • Market dynamics: These include competition, pricing dynamics, and barriers to potential competitors.
  • Management team robustness and depth: Acquirers, particularly private equity players, will partner with management after an acquisition. Showing a deep management team is crucial, especially if the entrepreneur plans to step back from the business immediately or over time.
  • Hygiene factors: These include well-documented and robust customer and supplier contracts, protection of intellectual property, and well-functioning HR and finance functions.

Combining Quantitative and Qualitative Factors for Accurate Business Valuation:

Combining qualitative and quantitative factors helps potential acquirers understand the business’s future potential and present an attractive valuation. Thorough preparation allows for a consistent story to be told.

Advisers are well-versed in presenting consistent information that tells a business’s full story to maximize its valuation and prepare businesses for the complete sales process, including due diligence, to ensure the final valuation package meets or exceeds the initial valuation tabled by an acquirer.

How MCF’s M&A Advisors Can Support Your Business Valuation:

Our team knows how to create competition; acquirers will always present a valuation that serves their interests, and we are skilled in working with both strategic and financial acquirers to drive up the valuation. If you are looking to have your business valued or have any questions about the M&A process, please reach out to one of our team members who will be happy to assist.

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