“Rarely will two valuers arrive at the same value for a business,” says Stephen O’Flaherty, corporate finance partner with BDO. This subjectivity can have its roots in various reasons, from attitudes to risk to the weighting given to intangible factors.
“At the most basic level, future earnings are the dominant metric used by most buyers when assessing the worth or value of a business,” says O’Flaherty. “After all, when buying a business you are buying its future cash flows not its past cash flows.”
Predicting the future is impossible, but valuation professionals use established techniques to reduce uncertainty.
“We will review the future prospects of the business; this can include, for example, assessing the sector outlook and reviewing the customer base to see if there is over-concentration on any one customer or region.”
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Valuation techniques include “not only looking at past market transactions but also looking at required equity returns and debt costs to ensure the valuation arrived at is robust and reflective of latest data. As valuers we have access to global databases of performance and transaction data as well as market premia.”
O’Flaherty advises keeping a keen eye out for variations between projected financial performance and up-to-date management accounts as due diligence progresses. “Sometimes sellers can be over-ambitious when setting out their projections, this is understandable as they are trying to paint the best picture possible for their business.”
“Arriving at a valuation for your business is part art and part science,” says Conor Cullen, transaction services financial advisory partner at Deloitte Ireland.
Once a valuation has been established, due diligence is the next critical step in confirming financial assumptions and identifying risks.
During the due-diligence phase, Cullen suggests buyers should hone in on quality of earnings, net working capital and net debt to determine the true equity value. “Potential value can be gained or lost through understanding the nuances within each and through understanding how best to position any adjustments in your favour,” he says.
“Taking quality of earnings in the first instance, a buyer should, at a minimum, be looking to understand the quality, visibility and growth profile of revenue alongside the cost base supporting this.” Any revenue challenges, unsupportable growth assumptions or an underinvested cost base can have a material impact on the proposed valuation.
When it comes to putting net working capital and net debt under the microscope, Cullen advises detailed reviews of balance sheets: “The devil is in the detail with value adjustments here requiring more nuanced thinking and positioning as these are typically ‘grey’ areas to be negotiated which can ultimately alter the valuation materially.”
Cullen says it is becoming increasingly commonplace to see sophisticated buyers using analytics at this stage of the valuation process “to deliver insight, support value drivers and increase efficiency by providing evidence of the drivers of business performance.”
Modern valuation is increasingly driven by data analytics, allowing buyers to refine their assessments with more precision. As data analytics becomes intrinsic to the M&A valuation process, the combination of extensive data points and advanced predictive modelling will enable expanded evaluations of potential opportunities and scenario forecasting, offering deeper insights into market conditions, competition and consumer preferences. Ultimately, it may lead to more successful integration, synergies and success rates for M&A activity.
One of the hardest pieces to put a price on in the valuation process is the human part. “Culture – and people, in particular – is sometimes the area that is given the least amount of weighting in a valuation by a seller but ultimately becomes the biggest factor impacting the valuation for a buyer – in particular in the context of a private-equity deal as they will typically be looking to partner with the management team to deliver on their investment thesis,” says Cullen.
“Obviously, the culture and people involved in the business are a key consideration for a buyer. In terms of valuation, if, for example, there is perceived reliance on one person within the business, then projections may be modified for valuation purposes through scenario analysis and or the application of a company-specific risk premium,” says O’Flaherty.
“Again, it is key that a holistic approach is taken to the valuation process and understanding the subject business and all its assets, both tangible and intangible, is key.”
Cullen agrees that ultimately the art of valuation is more than all the sum of the parts; a clear idea of how they interact is key.
“It is easy to focus on the financials – revenue growth, margin generation, revenue visibility and so on – as the foundations of an acceptable price. However, there are a number of intangibles that have to be factored into the assessment such as potential growth opportunities, the quality of the management team and sector dynamics like the size of the market and market growth potential. Key to underpinning any valuation is understanding how each of these components interact to ultimately determine the right valuation for you and having a trusted adviser to help you navigate this process is critical to creating realistic expectations of valuation for both the seller and a buyer.”
Ultimately, a successful valuation balances financial analysis with human factors, ensuring buyers and sellers align on realistic expectations, and increasingly this will be achieved by combining the resources of artificial intelligence and sound human judgment.
