Why Does Valuation Matter?
So much of the M&A literature focuses on valuation. But why does it matter? It’s a long and involved process with a lot of variability.
So much of the M&A literature focuses on valuation. But why does it matter? It’s a long and involved process with a lot of variability. Yet it’s critical to the process of exiting a business, and can inform many decisions you make in the coming years. So why is it so important?
Why Valuation Matters
Valuation establishes a business’s economic worth. The goal is to define fair market value, yet there’s no single strategy that can determine the price a buyer will pay. Value is ultimately determined by how much a buyer will pay, yet certain value metrics can help estimate this figure. Because value is subjective, two valuation professionals will likely disagree about the same business.
The status of your financials—not just what they say—will greatly affect value, particularly when you're planning to sell. Weak accounting records can have a difference of value of a multiple of 1 or more. This is because weak accounting records make it difficult for the buyer to be confident in anything else oyu report.
Dealing With Valuation
When seeking a valuation, it’s important to get as much information as possible, and to know your goals. Why are you doing this, and what do oyu hope to accomplish? The purpose of the valuation may govern the valuation methodology. Some common reasons for valuations include:
- valuations because of shareholder disputes
- valuation for estates and gifting
- valuation for disputes, such as divorces
- valuation for financing
Approaches to Valuation
There are a number of ways to value a company:
- The income approach can work for a specific concern. It may include formulas such as EBITDA, discounted cash flow method, capitalization of earnings, or an asset approach.
- The asset approach works well for companies that intend to liquidate.
- The market approach determines value relative to other companies, and is ideal when planning a sale.
No matter what method you choose, be mindful of some common valuation destroyers, which include:
- no or little recurring or reliable revenue
- no accounting records, or misleading accounting records
- weak management
- a lack of direction
- a company that is too owner-dependent