1. What is the business worth?
Business life cycle
What is the business worth?

2. Valuation methods Methods of valuation include:
Asset based methodologies
Market based methodologies
Earnings based methodologies
Industry based metrics

3. What is value?

4. Why the valuation is being done changes the value…
To improve value, helps to focus on key issues
To consider exit options
To raise financing, give confidence to lenders / attract investors
Motivation for staff
Taxation issues
Death/divorce
Why the valuation is being done changes the value…

5. Negotiation Synergistic value Key person value competition Demand
The value of anything is what someone is willing to pay for it
Synergistic value
Future income stream
Key person value
competition
Demand

6. Net Asset Value
ASSET VALUE = All ASSETS MINUS ALL LIABILITIES

7. Asset based
‘Entry cost’ – recreate the value of the company, what would it cost to set up the business being sold
‘Exit value’ – useful to estimate the “asset strip” value
Most helpful if the business has significant tangible assets i.e. property companies or in a break up scenario
Unlikely to calculate the fair value the future profitability
How to treat intangible assets (goodwill, workforce, competitive positioning, knowledge/skills brands, patents..etc)?
Can be useful in giving a minimum value

8. Net Asset Value It depends… … what is FAIR VALUE?
Book value is based on historic cost so unlikely to reflect an appropriate current value
Adjustments:
Fair value considerations i.e. old stock, fixed asset values, debts owed, provisions, intangibles
… what is FAIR VALUE?
Replacement cost
Net realisable value
It depends…

9. Example Notes Extract of Statement of Financial Position £000's
Plant and Machinery
Properties
Fixtures and Fitting
Net Current Assets (CA-CL)
650
Shares ( £1.00 )
Reserves
Loan
Notes
Intangibles – are estimated at £200,000
Plant and Machinery has a net realisable value of 300
Property is currently valued at 480
Fixtures and fittings have a negligible value

10. Market based
Market based simply means considering the sales price of similar items
Market based methods for valuation of a business use a multiple derived from market information (comparable guideline companies) and apply that to the Companies Earnings.
Commonly used PE ratio

11. Market based
As you are only using a single earnings figure then the value of growth has to be included in the multiple, this is a real challenge. What are earnings? Turnover, Net Profit, EBITDA What adjustments?

12. Multiples
The multiple is determined based on the required rate of return (a multiple is the inverse of the discount rate) thus it accounts for:
The market risk/risk of investing in a business
Risks inherent in the business, higher risk = higher required return
Size i.e Smaller businesses have smaller multiples than the listed companies
Growth i.e Higher forecasted profits increases the multiple
Stability i.e. more secure earnings streams increase the multiple
Alternative investment opportunities

13. How to determine a multiple
Other transactions in the market
Market valuations of listed companies

14. RELATIONSHIP 1/Cost of capital = multiple
Single period capitalisation model
Earnings £120 a year from now to perpetuity
Cost of capital is 12%
Gordon growth model:
Income stream………...
Rate of Return minus expected growth
120/0.12 = £1,000
Multiple is the inverse of the cost of capital i.e. 1/0.12 = 8.3x

15. What is ‘Earnings’
Maintainable Earnings Estimated with regard to: Historical earnings Forecast earnings Sensitivity to key industry factors Future growth possibilities General economic outlook

16. What is ‘Earnings’
Adjusted Earnings Consider payments to the owner, over/under market value Consider unnecessary assets and overheads Review any unnecessary staffing costs or staff working for non market rates Consider the financing needed to achieve the forecasted earnings (including the purchase of new assets)

17. Adjustments
Accounting EARNINGS
500
The owner pays himself a salary of £50,000, the market salary for a similar position is £80,000.
The owner pays an annual salary to his son of £9,000. His son does no work for the Company.
The business owns a small flat worth £125,000, there is no business reason for the flat. The running costs of the flat are £27,000 p.a
The business received a grant from the government last year of £32,000 because of a local initiative, this is a one-off income which has been recorded in the accounts as turnover.

18. EBITDA
WHY?
Company A and Company B both have Non Current Assets of £300,000. Company A depreciated at 2% pa, Company B depreciates at 5% pa. Company A has no debt, Company B has long term loans of £150 at 4%.
Company A
Company B
Revenue
100
Costs of goods sold 50
Admin and distribution costs 10
Depreciation 6 15
Operating Profit 34 25
Interest
Taxation (30%)
10.2
5.7
Net Profit
23.8
13.3
At a valuation multiple 4x
£95.2
£53.2

19. What are you valuing?
debt
equity

20. Company B Valuation EBITDA Multiple 5x Enterprise Value Less: Debt
Revenue
100
Costs of goods sold 50
Admin and distribution costs 10
Depreciation 15
Operating Profit 25
Interest 6
Taxation (30%)
5.7
Net Profit
13.3
At a valuation multiple 4x
£53.2
Company B Valuation
EBITDA
Multiple 5x
Enterprise Value
Less: Debt
Equity value

21. issues No two companies are the same
Adjustments to the multiple are highly subjective
Earnings are an estimate and based on historic results

22. Income based
Good for businesses predicting high future growth and/or variable earnings streams

23. Income based valuation
The value of a business is the net present value of its future income stream
Year
Expected Income 50 1 40 2 80
Discount factor
15%

24. Terminal Value
Valuation using the income method uses forecasts for a discrete period i.e. 5 years
At the end of the 5 years, for most businesses, it would be expected that income would continue. We can deal with this a number of ways:
Gordon Growth Model can be used to calculate the value of the final years cash flows in to perpetuity. This uses the simplifying assumption that the income of the company grows at a constant rate forever.
Exit Multiple

25. TERMINAL VALUE CALCULATION
The value of a business is the net present value of its future income stream
Year
Expected Income 50 1 40 2 80
Long term sustainable earnings 60
Discount factor
15%
Growth rate 2%

26. Industry based metrics
Examples of specific industry ‘rule of thumbs’
Hotel companies – value per room
Sellers discretionary earnings
Number of customers / outlets