Business Valuators are professionals that earn the bulk of their revenue preparing notional market valuation reports – that is, providing their opinion of the value of a business in the absence of an actual transaction having taken place (in the open market). Notional valuation reports are used for many purposes, such as divorce, tax and estate structuring and shareholder disputes. Business Valuators are necessarily in the habit of fastidiously preparing their reports and back up files because, often, they must be prepared to testify to their conclusions in court should the need arise.
Following the above, valuation reports are time consuming, expensive and therefore often not a desirable tool in real life M&A. But, beyond truly small business, there is still a more important reason why these reports are not, and should not, be relied upon when selling: they are inadequate for the purpose.
Businesses are sold to either strategic or financial purchasers. Strategic purchasers are those that anticipate gaining some synergy from the combination of the purchased and existing operations. Financial purchasers do not.
Financial purchasers, by definition, are purchasing the business as an investment. They generally have a pre-determined model, an approach, to evaluating opportunities. They are generally sophisticated and, if not, have transaction advisors to assist them. Presenting an independent valuation opinion to a financial purchaser accomplishes very little because this prospective purchaser has specifically geared up to arrive at its own conclusions. As a group, they tend to place little reliance on outside, independent opinions.
Strategic purchasers, in theory, should be prepared to pay more than financial purchasers because, in addition to the sustainable value of the operations to be purchased, the strategic purchaser is gaining incremental value on consolidation with their existing business (synergy). A valuation report is incapable of both: a) quantifying the anticipated synergy; and, b) deciding what amount of the synergy, if any, should be in the purchase price (the strategic purchaser premium). In a notional (theoretical) market, a valuator accounts for the strategic purchaser premium in the applied multiple because the multiple is arrived at, to some extent, with reference to historical, actual open market transactions completed by strategic purchasers. But, by necessity, this is an averaging exercise and therefore not relevant to any specific prospective purchaser.
What does all this mean for vendors? We are often asked to prepare valuation reports for those considering the sale of their business. We generally say no, on the premise that they provide little value.
Rather than an opinion of value, we believe prospective vendors should be more interested in, and should seek from their professionals, certain financial analyses and comments, with respect to:
i) the likely methodologies purchasers may use to value the business;
ii) the range of multiples (if appropriate) that may apply to the business and its industry;
iii) for internal planning purposes, an estimate of a possible transaction price, applying the above to financial information provided by the company; and,
iv) the drags on a possible transaction price, such as personal goodwill issues or poor quality financial information, and advice on how to mitigate these issues.
With this information, a prospective vendor will be armed to negotiate price with a financial purchaser and can plan, design and implement a thoughtful sale process for strategic purchasers, intended to maximize the premium included in the sale price.
Posted by Scott Sinclair, Range Advisors
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