How to Value a Company for Acquisition
In this article, we will look at the concept of acquisition and company valuation, and then we will go through the process to value a company for acquisition.
Valuing a company for acquisition is a process that involves a number of steps and considerations. Well, acquisition refers to the buying and selling of one company by another; valuation, in this case, is the process of determining the fair value of a company. A company’s fair value is the price an acquiring company would pay in order to acquire the entire company. In general, the fair value of the company is usually determined by various calculations, predictions, and analyses. There are many techniques, models and methods to determine the fair value of a company. In this article, we will look at the concept of acquisition and company valuation, and then we will go through the process to value a company for acquisition.
Company valuation and acquisition
Before we get into the process to value a company for acquisition, let’s briefly discuss the concept of acquisition and company valuation. An acquisition is when one company buys another company, and the acquired company is called the target company. It can be distinguished from mergers by the fact that the target company remains a legal entity after the acquisition; it is not dissolved and merged into acquiring company.
On the other hand, a business valuation or company valuation is the process of evaluating the fair value of a company, or in other words, determining the economic worth of a company. In this way, when a company is acquired, valuing the target company for acquisition is a crucial step in the acquisition process. Therefore, a company that is being purchased is usually valued through a business valuation model.
What is company valuation?
The term company valuation refers to the process of evaluating a company in monetary terms. In this process, the value of a company is determined or estimated by looking at various financial characteristics, assets, liabilities, projected cash flows, and other related business information. While company valuation is commonly referred to as business valuation, and thus sometimes the two terms are used interchangeably. The goal of the process is to estimate the value based on the financial metrics of a company for the purpose of making decisions about the business, such as investments, sales and purchases, etc.
How does company valuation work?
In the process of company valuation, financial metrics including comparable data, net assets values, discounted cash flow analysis, and other relevant data and information are gathered. Then, the information is analyzed and put into a form of evaluation in order to determine the fair market value of the company. Remember, based on the valuation model, the inputs and calculations will vary, and thus the results of the valuation may also vary. The estimation is not a perfect science and therefore, some amount of uncertainty and error might be present in the final result. As a result, it is recommended to use a combination of multiple methods in order to arrive at the best result possible.
Benefits of company valuation
Valuing a company is an important step in the business decision-making process, and it has many benefits. The following are the company valuation benefits:
- Determination of company assets – Usually, when a company is valued under an asset-based approach, the valuation includes the net asset value of the company, i.e. tangible assets and intangible assets. In this way, it is possible to determine the value of total assets, and it may be used to evaluate the company’s overall value.
- Determine the resale value of the company – The main idea behind a business valuation is to evaluate the true economic worth of a company, or in other words, determine its fair market value. As a result, based on the company valuation, the resale value of a company can be estimated.
- Determine the true value of the company – The concept of company valuation is to determine the true value of a company after taking into account many factors, including financial indicators and assets, liabilities, and other related information. Therefore, when a business valuation is done, the true value of the company can be determined.
- Access to more investors – The other important purpose of a company valuation is to provide access to more investors. Potential investors often use the results of a valuation to evaluate an investment opportunity. Therefore, this helps businesses get access to potential investors for business expansion or other such purposes.
Valuing a company for acquisition
Now that we have a general understanding of what a company valuation is and why it is important for the business, let’s discuss the process to value a company for acquisition. In the following section, we will look at the basic concept of acquisition along with the various steps to value a company for acquisition.
What is the acquisition price of the company?
As the name suggests, acquisition price refers to the price at which an acquirer purchases a target company. In other words, a company’s acquisition price is the total sum of monetary value paid in order to acquire the company. This is determined based on a combination of factors, such as the value of the target company, the stage of the company and the circumstances surrounding the acquisition.
However, because a significant portion of the payment made may be in terms of buyer’s equity, the acquisition price can be affected by how the market responds to the transaction. Overall, the acquisition price, which is also referred to as the transaction value is the total price paid to acquire a company.
Why should you value your company for acquisition?
The process of valuing a company for acquisition is crucial during the acquisition process. This is because the acquisition price is based on the value of a target company, which in turn depends on how much a prospective buyer is willing to pay. This means that a company being acquired can be valued by experts through a company valuation model, and thus determine its true value from the perspective of an acquirer. In practical terms, the price of acquiring a company is majorly determined based on the valuation, and thus with the help of an accurate valuation, a fair deal or transaction can be reached. So, the most important reason to value your company for acquisition is to get a fair deal with the prospective buyer.
Steps on how to value your company for acquisition
Probably you know that company valuation is an important step in the acquisition process. The process of valuing a company for acquisition consists of assessing a company from various aspects. Below mentioned is a list of steps involved in valuing a company for acquisition that are divided into three phases:
Determine the level of valuation
In the first step, the company valuation is done based on a combination of financial indicators. A valuator can create three types of reports, from basic to fully detailed which are as follows:
- Calculation report – This is a basic valuation report which can be done with minimal information. For instance, sales data, operating expenses, and additional general information can be included in this report. Such a report might be appropriate to create a rough valuation evaluation.
- Estimate report – In comparison to a calculation report, an estimate report offers a better level of assurance and a mid-level of depth. It frequently entails reviewing and verifying company data, and it could include sales analyses by service line or division. In fact, estimate reports can be used for acquisition purposes
- Comprehensive report – The comprehensive report is the ultimate form of the valuation report. Of course, this entails all kinds of information such as economic and market research as well as detailed company analysis. Furthermore, comprehensive reports may also include valuations from different perspectives like sales, earnings and cash flows.
Collect business information
After gathering the necessary information through the above-mentioned steps, the next important step is to collect all the available information related to the company. The information you need to consider includes the financial statements for the previous three to five years, the preceding year’s tax return, a list of optional and one-time expenses, the number of employees, the location of the business, the square footage of its facilities, and whether it is owned or rented, as well as patents, rules and regulations, and shareholder agreements.
In addition, a breakdown of sales over the previous three to five years by the customer, statistics on product margins and supplier concentration by service line might also be required.
Apply valuation methods
The next step involves applying company valuation methods in accordance with the available and relevant information. During this step, you need to examine all of the acquisition valuation methods and choose the most appropriate one. Here are some of the valuation methods:
- Market-based approach – The market approach is the one which is widely used during the acquisition process. Basically, a valuation multiple is used, which may be based on revenue, EBITDA (earnings before interest, taxes, depreciation, and amortization), or other factors. There are numerous different types of ratios, and the particular figure used varies widely based on each. As a result, you need to keep in mind that they can affect the end result in a very significant manner.
- Cost-based approach – The cost approach is a popular method that uses the cost to duplicate or replicate a business. Basically, the cost of reproducing the same business is determined by adding up all of the expenses that are required to be incurred in order to replicate or reproduce each of the company’s business functions. Based on the cost to reproduce the business, the valuation is determined. However, this approach has its limitations since it only accounts for expenses that would have been incurred in doing the business.
- Asset-based approach – As the name implies, the asset approach is based on the value of the assets owned by a company. In simple terms, the company’s assets e.g., tangible assets such as land and buildings and intangible assets such as intellectual property are added which are then subtracted from the total liabilities of the company. This results in the net asset value of the company based on which the company’s value is determined.
- Earning-based approach – For companies that are profitable and have a value that exceeds the sum of their net assets, earning-based methods can be used. In this method, the future cash flow projections of the company are assessed, and these cash flows are then discounted to present value in order to measure the company’s value. As a matter of fact, this method is also known as the discount cash flow or income method, and thus it involves the use of earnings/cash flows.
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