Valuation methodologies
If you are considering selling and buying a business, it would be advisable to get the company valued according to customary market practices. This way, the seller crystallizes his selling price request, rather than delay the decision (potentially, indefinitely) and avoids the seller overestimating the market value of the company (e.g., arbitrarily seeking €1 million, based on “gut feeling”). Conversely, through a valuation, potential buyers avoid offering prices to sellers that are principally driven by their own funding constraints, far removed from (below) the business’ real valuation. Further, if a valuation is carried out sufficiently ahead of a business’ sale, an advisor should be able to prepare the company for sale (e.g., reviewing expenses incurred to remove avoidable expenses).
There are multiple methodologies to determine a business’ value, which are likely to provide different valuations for your consideration. A brief description is provided below.
The “asset value” methodology
Is the methodology utilized by Malta’s capital gains taxation legislation. The valuation starts with the calculated net asset value from the prior year’s financial statements, which is then adjusted to revalue:
This valuation carries the benefit of being clearly defined in Maltese legislation for the seller to pay capital gains and is particularly relevant for asset-intensive companies (e.g., significant real estate or equipment requirement).
The comparable company approach
It actually refers to two methodologies:
The cashflow based (income-based) approach
Is particularly popular and internationally accepted as the company’s future prospects determine its valuation; therefore, this methodology requires the company to forecast cashflow expected to be generated annually, and discounts this at an interest rate commensurate with the company’s risk.
A company’s business forecast (frequently over several years e.g., 5 years) should be carefully drafted, based on plausible assumptions and translated into integrated model financial statements, as these will have a decisive effect on the company’s valuation. For example, carrying out PESTEL and SWOT analyses prior to the business’ valuation will help inform planning assumptions, reducing subjectivity.
These analyses will further assist to assess the discount rate most commensurate with the business’ risk, including the higher risks typically associated with smaller businesses (e.g., limited market share, exposure to competition, reliance on few individuals, reliance on few customers, higher input costs), which usually results in elevated discount rates e.g., 15–20%.
Since there is a fair amount of subjectivity involved (both the planning forecasts, and applicable the discount rate), the breadth of plausible valuation supported is likely to be broad.
As mentioned, each valuation methodology will provide an approximate valuation – where these valuations overlap, that would indicate the most plausible of valuation for discussion. Further, this valuation would represent the business’ valuation, so should the business have external debts (e.g. with financial institutions), then this would need to be deducted from the valuation. The valuation would need to be further adjusted, for example, should there be minority partners, for the percent of shares that are not acquired and for the “inconvenience” of potentially needing to consult with third-parties for certain decisions (e.g., significant investments in equipment).
Engaging an advisor
If you are thinking of selling or buying a business, a professional advisor could assist you by providing you with an estimate of the company’s valuation.
Typically, to determine this, an advisor would carry out the tasks listed below (or a subset of them, particularly for smaller businesses):
Should you want support with estimating a business’ valuation, reach out to your financial advisor or BusinessExchange to discuss.
