Different parties may have diverging views on where the true measure of value lies. Professional corporate valuations are a tried and trusted way to help parties understand value via the application of established methodologies.
A ‘rule of thumb’ approach is no longer acceptable
Currently, we are seeing increased demand in the marketplace for corporate valuations. Many of these requests come from parties considering a sale of their company and may represent the first step in the process that subsequently leads to an M&A transaction.
In addition, there is growing demand to undertake valuations to assist with mediation and/or litigation in cases of conflict, as well as providing valuations for accounting for corporate business combinations in accordance with IFRS 3 – for example, Purchase Price Allocation (PPA).
While this is welcome news for firms which specialise in this area, it is important to understand that while some advisors may have adopted a ‘rule of thumb’ approach in the past, with all parties accepting that valuation is not an exact science, such an approach is no longer acceptable in today’s more complex business world which demands a more comprehensive approach to valuations. In addition there is now enhanced scrutiny of valuations, particularly those emanating from restructurings, succession/tax planning and conflict resolution.
Valuations must be demonstrably robust and comprehensive
Specifically, tax authorities are increasing their focus on company valuations, and will now often appoint an independent third-party valuer to review a valuation performed on behalf of a taxpayer.
In cases where a business or asset has been adjudged to be over or under-valued, this in turn can lead to an undeclared tax liability. In such circumstances any undeclared tax assessed will have to be repaid, together with any interest and penalties, along with the potential publication of the taxpayer as a tax defaulter.
Therefore, it is critically important for clients to ensure they commission valuations that are demonstrably robust and comprehensive.
While it is rare to have two valuers arrive at the exact same valuation of a company, the methodology applied in arriving at a valuation must be robust and stand up to scrutiny, be that through reviews by tax authorities – for example, if the valuation was carried out for the purposes of a restructure – or for any other purposes.
Establish a thorough understanding of a company’s strengths and weaknesses
There are three main recognised methodologies for determining a corporate valuation: the income method, the market (multiple) method, and the asset approach.
For most trading companies, the asset approach is likely to understate the value versus the value that would be arrived at by applying the market approach or the income approach. However, in certain circumstances (such as a loss-making or poorly profitable trading entity, or where the value of a company is more closely related to the value of the underlying assets as opposed to its earnings capacity e.g. real estate companies) it may be appropriate to apply the asset approach.
A robust valuation begins with establishing a thorough understanding of the company’s business and its strengths and weaknesses, as well as the sector the company operates in and the external risks and opportunities to which it is exposed.
The next step after thoroughly reviewing both company and sectoral data is to look at market and transaction-related data (both domestic and global data, with a focus on the former where there is enough data available).
Valuations require appropriate levels of commercial acumen
The final stage is to select the most appropriate valuation methodology and, in many cases, to also apply other methodologies, either to corroborate the valuation derived from the primary method or to highlight variances requiring further thought or consideration.
While valuations today are very technical in many respects, they equally require appropriate levels of commercial acumen. This is to assist in determining key factors such as appropriate market multiples as well as costs of capital inputs (cost of debt, equity risk premium, etc) in arriving at appropriate discount rates for undertaking discounted cashflow (DCF) models and also extends to helping to determine other variables such as:
Ultimately, the valuer needs to apply his or her professional judgement in arriving at their valuation whilst leveraging the established methodologies referred to above.