Share valuations
In this article we will cover the following topics:
- Why value a company’s shares?
- How to value a company
- Applying company valuations
1. Why value a company’s shares?
Potential reasons for valuation may be:
- Selling a company
- Management buy-out
- ESOP
- Raise capital
- Taxation
- Litigation
- Part of a divorce settlement
- Estate planning
You should note that the value of a company’s shares is influenced by the reason you are asking the question. By changing the purpose of the valuation, you potentially change the value of the shares.
2. How to value a company
Valuation Methods
2.1 Asset based valuations
2.2 Multiple based valuations
2.3 Discounted cash flow / NPV
2.4 Other methods
You may need to adjust the company financials prior to applying these valuation methods.
Example: A Ltd – Security and Facilities management company
Recent actual results and forecast results for the next 3 years are as follows:
Adjustments to financials
In this case, an adjustment is required to EBITDA for an element of depreciation, as the Company has replaced its fleet of leased vehicles for purchased vehicles, in doing so, the company immediately improves its EBITDA position as lease cost is replaced by depreciation. This is unrepresentative of the actual situation as the company still uses the same number of vehicles. This therefore needs to be adjusted in order to present a like-for-like annual position in the financials.
Other potential adjustments
- Directors remuneration
- Related party transactions
- Exceptional items (goodwill write off, defined benefit pension etc)
What is the value of A Ltd?
2.1 Asset based valuation
This method uses the adjusted company balance sheet.
There are various ways of valuing the assets:
- Book value
- NRV
- Market value
The valuation can be affected by specific accounting policies.
This method includes the value placed on intangible assets.
Asset based valuations ignore future profitability, and are therefore useful for break-up valuations.
2.2 Multiple based valuation
The value of a company is determined through comparison to similar companies in the market.
a) Listed Companies (PLCs)
- Identify comparable PLCs in a similar industry.
- Apply an adjustment to the profit multiple that represents a lack of marketability on the company you are valuing in comparison to publically traded companies. The private company price index (PCPI) is c.20% reduction.
b) Corporate transactions
- Look for multiples paid in recent deals across the sector and use as guideline considering;
- Timing of past transaction
- Nature of business acquired
- General economic conditions
- No PCPI adjustment is required
2.3 Discounted cash flow valuation
This method calculates the value of the company today based on its future cash flows, and typically requires a detailed cash flow spanning 3 – 5 years.
To determine the operating cash flow EBIT is often used as a starting point.
Assumptions are required for:
- Discount rate
- Growth rate
Recognition must be taken of the fact that the forecasts and assumptions are highly subjective.
2.4 Other methods
Industry specific approach
- Hotels – value per double bedroom
- ISP – value per subscriber
- Breweries – value per barrel
Industry rule of thumb
- E.g. manufacturing = 4 x EBIT
Not scientific – but often provide useful benchmarks
3. Applying company valuations
Understanding the valuation results
The next stage is to understand what value you have derived from the above methods.
- Enterprise value is the value of the business
- Debt free, cash free valuation is similar to the Enterprise value (used for deal comparison)
- Equity value is the value of the equity
Equity Value is equivalent to the Enterprise Value less debt. To obtain a comparable value between Equity Value results and Enterprise Value results, the Enterprise Value obtained from the profit multiples must therefore be adjusted for the net debt / cash in the business.
Review range of values:
Where there are large ranges in the valuations relied upon, these should be investigated. In this instance th the Asset Based valuation is ignored as it is less appropriate for this type of business. The Comparable Transactions valuation is also ignored as the deals all took place within a buoyant and incomparable market.
Applying the results to specific circumstances
The final stage is to apply the overall Equity Value to the shares for sale, taking into account the specific circumstances of the transaction; i.e. the reason for the valuation or the number of shares held.
Common amendments would be for the:
- Marketability of shares
- Class of share
- The degree of control that the shares would grant / percentage ownership
There can often be significant discounts for lack of control, a discount of 40% is not uncommon.
Valuations are an Art not a Science!
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Contacts
Denise Friend denise.friend@friendllp.com 0121 633 2000
Mark Scotter mark.scotter@friendllp.com 0121 633 2019
Georgina Clark georgina.clark@friendllp.com 0121 633 2034
