The ways and means to obtain credible business valuations are nearly as numerous as the types of businesses themselves. When it comes to the valuation’s audience, there are only two types of valuations needed: those meant for internal use and those meant only for external eyes. In the world of M&A seldom shall the twain meet.
Recycling a particular valuation from one business to a diametrically opposed company in a completely different industry is certainly a blunder in its own right, but more often than not the equal blunder is made when valuations meant for internal purposes become fodder for M&A discussions and deal negotiations. Because valuations represent a simple snapshot in time, a look at the business in a specific year with assets that may change, even a recycled internal valuation of a particular company can oftentimes lead to trouble. Internal vs. external valuations can also be in conflict when fair market value is confused with or substituted for book value or visa-versa. Recycled valuations in general can lead to misinformation, breaches in reps, warranties and fiduciary duties and even land the seller some costly time in court.
While some operators feel recycled valuations for any purpose can help to save time and money, it’s typically a textbook example of being penny wise and pound foolish. Time and experience have shown that cookie-cutter valuations swapped between companies and even stakeholders of a single company can be detrimental to the eventual payout of the business. Moreover, recycling a valuation from one year to the next can sometimes cause more than minor errors that later can zap credibility.
Purpose of the Valuation
Some valuations are used to value shares in the company for things like gifting the business to a child, divvying up assets to a dissenting shareholder or valuing assets for alimony during divorce proceedings. Each valuation is done for a particular purpose and for a specific end. For our purposes here, we’ll be referring to business valuations prior to the ultimate sale of the company.
Prior to initial engagement, we provide a standard 5-point or 5-method evaluation of the company with whom we’ll eventually represent—providing and expected range the seller could hope to expect from the business at the time of sale. The purpose of this valuation is threefold. First, it gives us, the valuators, a better look at how the business operates and what we can expect from potential acquirers for such details as earn-outs, reps and warranties, etc. It also helps the M&A advisor to assess the amount he/she can expect in terms of a final fee from the company. Second, it can help to set expectations for the seller and the seller’s shareholders (which are many times out-of-whack). Finally, it gives the advisor a benchmark to beat by when it comes time to engage multiple buyers in a strategic auction.
Valuations and Information Asymmetries
When doing deals, it is important to be forthcoming with all information in a transaction. Due diligence and reps and warranties are meant, most often, to protect the buyer from acquiring a non-performing lemon business. However, it doesn’t mean that your M&A dealer is required to share valuations, ranges, rules of thumb, multiples, WACC calculations and internally calculated (including that calculated by the advisor) with the potential acquirer. Information asymmetries will not exist when it comes to the data, but the interpretation of the data is up to the individual parties involved. We also adhere to the mantra:
When two liars are involved, the first liar doesn’t stand a chance.
Sure, as a seller’s agent, we are beholden to maintain the integrity of the transaction by being transparent and forthcoming with all previously proprietary data, but giving away expectations, especially early on is like showing your hand in poker—an obvious misstep.
Strategic Auction Process
In nearly every deal we represent, we engage the seller in such a way so as to maximize the eventual payout of her business. As part of this process, we take our valuation range which is based on multiple effective methods and look at the top of the range—and beyond—as the ultimate goal in the transaction.
Once we’ve the top of the range, we focus on strategic business buyers for the business, often keeping financial buyers like private equity groups in the deal for safety, but on the fringes as a second tier priority. Managing a strategic auction scenario requires a rigorous and structured path to completion including the invitation of multiples strategic buyers interested in growing via acquisition. Nowhere could the mistake of sharing a company’s internally-focused business valuation be more detrimental than in a strategic auction scenario.
A dichotomous polar-opposite approach is made when sourcing buy-side mandates from acquiring clients. In this scenario, a detailed approach to extruding the firm’s weaknesses is used. Finding the holes in the company’s model, finances, operations and the industry or market in which it operates can help those engaged in acquisition tell a reputable story as to why the business is worth significantly less than the seller hopes to obtain.
However, buy side deals, while different in structure methodology, require the same disciplined focus on privacy when it comes to assumed valuations.
To be clear, we regularly recycle PowerPoint presentations, CMM formatting, valuation methodologies and Excel templates, but we avoid the cookie-cutter blunders inherent in providing the same or similar valuations for all stakeholders in a transaction scenario. Timing, rules of thumb, differences in structure, changes in the industry, marketability, location, seller goodwill and strategic fit also play a role in the “art” side of determining value. Valuing a business is much more difficult than simply looking at the value of the underlying assets and pegging market or book value on them. Opportunity is created when data and information is properly gathered and expertly interpreted. Don’t make the mistake of a botched interpretation. Value it right, on time and keep the findings to yourself.