Business Valuations
The fundamentals of business valuations for lawyers
In this blog I explain the fundamentals of business valuation to assist family lawyers and lawyers acting in litigation and dispute resolution. A basic understanding of business valuation methodology is key to understanding the whys and wherefores of the valuer’s expert report.
Valuation is a mixture of science and art. The expert valuer starts with the theory – that’s the science – and brings their own experience to bear in deciding on the appropriate methodology and assumptions – that’s the art.
Ultimately, a business is worth what someone will pay for it. However, as valuation expert we are typically preparing a theoretical valuation. A business valuation may be required in various situations including:
• Divorce;
• Family disputes;
• Shareholder disputes including unfair prejudice claims;
• Valuations for employee share schemes or director incentive schemes;
• Tax reporting e.g. inheritance tax or tax planning;
• Commercial disputes such as agency disputes;
• Professional negligence claims.
Key valuation methodologies
The starting point in valuing a private company or a shareholding in a private company is the selection of a valuation methodology. In some situations, we will use two or three methodologies and compare the output.
The key valuation methodologies adopted by expert valuers for private company and business valuations are:
1. Future maintainable earnings. This is described as an income approach. In essence the valuer estimates a figure for future maintainable earnings and applies a valuation multiple to give the enterprise value. The valuation multiple is effectively the number of years a purchaser might be willing to wait for the return on the investment to materialise. The enterprise value is then adjusted for the cash/debt and working capital in the business to arrive at the equity value.
2. Discounted cashflow. This is the ultimate income approach whereby future projected cashflows are converted to a current value using a risk adjusted discount rate.
3. Asset based valuation. This is described as a cost approach. Using this method, the business is valued based on the value of its net assets with no reference to future profits.
4. Entry cost method. This is another cost approach and looks at the estimated cost to set up a similar business from scratch.
5. Dividend yield. This method is an income method adopted to value minority shareholdings.
6. Industry precedent. In certain industries there are guidelines used such as a multiple of income or numbers of customers.
A couple of examples from Middle Earth
An example of a valuation of Bilbo Baggins Limited adopting capitalized maintainable earnings:
A, B and D are the key variables to assess
Another example is a valuation of Bombur Limited adopting an adjusted net asset basis:
In our valuations of private companies, we typically value the company adopting the future maintainable earnings method. This is used for companies which are trading and producing a commercial return to the shareholders. In calculating our valuation, the key variables are:
1. The assessment of maintainable earnings (usually EBITDA);
2. The earnings multiple;
3. The net cash/debt and any working capital adjustment.
The second most common methodology we adopt is the adjusted net assets method. This is normally relevant if either:
• The company is not making a commercial return i.e. loss-making;
• The business is not trading;
• The company is asset rich such as a property investment company;
• In respect of holding companies which do not trade but hold investments in subsidiaries (each subsidiary will be valued depending on its own situation or a consolidated approach may be relevant).
Conclusion
Valuation is subjective and two valuers may reach very different conclusions depending on their choice of methodology and their assessment of the key assumptions. At FHM Forensic Accounting we can prepare comprehensive valuation reports for court or commercial purposes. We can also provide a preliminary view on valuation to assist in negotiations and assessing strategy. We will also review the reports of other experts, often as Shadow Adviser to assist you in critiquing the expert’s valuation and asking appropriate questions of the expert.
Getting in Touch
Fee estimates and CVs are readily available. Quotes can typically be provided within two working days.
Email: fiona@fhmforensic.co.uk
Telephone +44 (0)7770 642491
