One of the key questions to ask when buying or selling a part of or your whole business, is what should I pay or what I should sell for. When answering this pertinent question, we have to look at value. However, few people understand the concept of value.
I then get asked “well what exactly is my business worth?”
My answer is: “The bad news is, a valuation is not an exact science!”
The concept of the value of an equity interest for fiscal purposes is “what it will fetch in the open market”. In the absence of a price quoted on an active market, a valuation will have to be performed. The conceptually sound basis for arriving at value is to discount the projected cash flows at a fair rate of return (the DCF model).
In the case of a controlling interest, the value is the higher of the value arrived at using the DCF model and the value arrived at assuming that the entity is wound up (the liquidation model).
Telling the future
Thus in most cases a valuation is a discounted vision of the future depending of the nature of the transaction. You will ask: “How can you tell the future?” My response is: “Now you understand the concept of value.”
There are many factors affecting value which requires an analysis of the past performance, current risks, future outlook and why am I buying or selling (my strategy). Valuations are based on acceptable methodologies, but most important are the value drivers behind these.
Preparing a Due Diligence or Information Memorandum
It sometimes amazes me that anybody can go into a transaction without performing a Due Diligence or preparing an Information Memorandum which should cover a wide spectrum of risk factors and value drivers. The seller needs to prepare an Information Memorandum and an Investment Opportunity Summary for the market and the buyer needs to perform a Due Diligence. Both require an analysis of the target entity and the industry and markets it operates within.
Part of the objective of the first steps in this process is to determine is it worth selling or what my returns will be with my associated investment in buying or should I rather decide on a start-up business. In other words, what are the associated risks and your expectations regarding the price you are prepared to sell for or you are prepared to pay.
Determining an acceptable price
Finally, determining an acceptable price is not the only challenge. You also need to structure the buy and sell financial structure, as well as structure the buy and sell conditions and parameters. This could have a significant effect on the price and returns.
As you can see, buying or selling a business is not a simple process, but it should follow a logical sequence of events. We will discuss more about this topic and about Business Planning and feasibilities in our future newsletters.
If you require further information on this or other business matters, contact your nearest GBS office.
Herman Coetzee