How corporate valuation works?

Deciding how much to pay for buying a business

• There are several approaches to business valuation – none is perfect.

• A small business and large Public Limited Company are valued differently.

• Multiples of yearly revenue of the business is often used as a ballpark figure (but things are always not that easy).

Determining Assets of business

• A business can have two types of assets

• Tangible assets like open market value of stocks, equipment, buildings, equity etc. – this part is comparatively easy to compute.

• Intangible assets like goodwill, intellectual property, copyrights, trademarks, patents, etc. – this part is hard to calculate.

• Calculate discounted cash flow from future return – i.e. what will be revenue if new business continues to sell same goods (and same customers continues to buy)

• What will be prospective (future) sell price of intangible assets?

• How much scalable will the merged/acquired business be?

Factors to consider

Avoiding duplication

• How much money can be saved by avoiding duplication? i.e. one head office instead of two, reducing staffs by removing duplicated works (Do you now understand why mergers/acquisitions invariably follow job losses?)

Calculation for buyer

• How much profit (in what time period) can be achieved in new acquired business?

• Profit = Cost saved via reducing staffs – redundancy staffs + new warehouses – old head office – tax + other things – other things etc.

Buyer’s and seller’s view points

• Buyers works out how much profit they hope to achieve from buying the business and running it in a different way, taking into account financing costs, redundancy costs, etc., and then applies their own requirement of investment rate of return and some form of provision for future sale of the business.

• Likewise the seller does the opposite - looks at what investment return they can get from investing the proceeds elsewhere rather than profits of the business being sold. Somewhere there will be a middle ground where both parties are content.

The bottom line

• It is quite likely that the "price" for a business can be different for different potential buyers and almost identical businesses can be sold for vastly different amounts because of the situation of the seller. It is also common for the "proceeds" to be structured in different ways, i.e. shares instead of "cash", earn-outs, etc., often for tax reasons - a seller may decide to sell for €9m in such a way that tax is only €1m rather than sell for €10m in such a way that the tax is €3m.

Each business is unique!

• Things are very different for small owner managed companies which often command very small earnings multiples of maybe 2-3 as opposed to national or international Public Limited Companies, that may command multiples of 10-20 times earnings.

• Service companies might be sold for 1-2 times of yearly revenue yet product companies may be sold for 10 times of their yearly revenue!

What it means for public?

• Often there is no short term impact on common people when two conglomerates merge. However, on long run, a large business may force smaller players out of the market thus creating a monopoly.

• This is bad for consumers as there is less competition, large business command any price for their service!