The valuation of any business is a complex issue. Whereas companies with shares valued on a recognised stock exchange can be determined by reference to an appropriate index quoted in the financial press at a particular point in time, the valuation of a private business ( whether it be a limited company, partnership or sole ownership)company is more subjective. The purpose of the valuation and the circumstances in which it is being carried out can have a significant effect upon any valuation exercise, and rather than a single definitive valuation, there is always more likely to be a range in which a reasonable valuation will lie.
The fundamental aspect that determines the value of a shareholding is ultimately what a prospective purchaser might be prepared to pay for it. For shares in any company the market is inevitably restricted to those people and institutions prepared to pay for shares, which are in essence nothing other than a bundle of rights and liabilities possessed by the shareholder. For a private company there is an additional restriction in the real market being any restrictions on transfer contained within the company’s Articles of Association.
Valuation methodologies applied to the appraisal of any business interest, shareholding or asset may broadly be classified into three main approaches namely:-
· Income approach;
· Cost / net assets approach; and
· Market approach.
We undertake calculations using all three approaches, if relevant, to arrive at the narrowest range for the valuation.
The income approach is usually applied when valuing a profitable business as a going concern. The approach involves assessing the maintainable annual earnings before interest, tax, depreciation and amortisation (EBITDA) of the business and capitalising these by reference to an appropriate enterprise value (EV/EBITDA) multiple to arrive at the enterprise value.
It is a matter of professional judgement as to what factors should be taken into account in establishing the level of future maintainable EBITDA and the EV/EBITDA multiple appropriate in any particular circumstance. It is usual to examine the past performance of a company to see if any trends can be established and also to look at future prospects and also to see if any items of a non-recurring or none arms-length nature have been included.
The enterprise value of a company is then adjusted to an equity value by removing debt and adding cash before typically being compared with the net assets on the balance sheet of the company. If the income approach results in a higher value than one achieved using the net asset approach this suggests a level of unrecognised goodwill in the company. However, in circumstances where an income approach results in a lower valuation than that achieved using a net asset approach this could indicate that:
· The company has negative goodwill; or
· The income approach is possibly not appropriate for the particular company.
Cost / net assets approach
The net assets approach is most commonly used for businesses which have a large asset base relative to its trading performance, such as property investment companies or where the company has a level of net assets which appear to be in excess of those needed to operate on a day-to-day basis. This will normally occur through the excessive retention of internally generated profits or where the company holds other surplus assets within its balance sheet such as property or cash.
The net asset approach indicates the market value of a business by adjusting the asset and liability balances on the subject company’s balance sheet to their market value equivalents.
The market approach is a valuation method that can be used to determine the value of a business by comparing the subject company to similar companies in the public domain, to information from publicly available transactional information in the same industry and to past transactions in the object company itself, making any necessary adjustments for differences in size, quantity or quality.