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What's the best method for business valuation?


Topic Expert
David Wittenberg
Title: Director of Financial Strategy
Company: World Vision
(Director of Financial Strategy , World Vision) |

Acquisition/divestiture valuations differ from employee stock valuations for an unproven start-up which differs from tax valuations. I'll take the more common acquisition/divesture situation.

As unglamorous as it sounds, a thoughtful after-tax cash flow projection remains the most effective method for business valuation.
● Cash flow models force the decision-makers to come to terms with what they must believe to accept the final valuation value or range. Comparables (comps) and multiples are largely a black box.
● Cash flows can be used for follow-up and accountability after the transaction. With a comp or multiple supplied by your IBanker or industry statistics, no one in the business is really accountable for anything. After all, we used "facts & data."
● Cash flows can provide valuable lessons for making better valuations and decisions in the future. We can learn why, for better or worse, reality differed from our projections (assuming we take the time and discipline to review).
● Comps are a reflection of past transactions with little insight into whether it was a good decision or if others are regularly over-paying. As mom said, "If all the other kids jumped off a bridge…" History tells us the majority of acquirers overpay, so what does that say about using comps?
● Other transactions may reflect a different time in the business cycle or very different business models. For example, comps between a business with premium product mix applied to a business competing on price may be completely invalid. A valuator may "make some adjustments" to the comp value in an attempt to correct, but based on what?

Despite their unreliability, comps and multiples are very useful for understanding the mind of the other parties relying on comps. Our IBankers can use that to our advantage. For example:
● We may find that comps don't reflect special circumstance that make a business' cash flow value (i.e. fundamental value) higher than the comp's result. In this case, we could target a lower acquisition price.
● Alternatively, we may see the market comp could lead bidders to over-value an asset. Acting on that bias, we may enjoy a windfall by put a business up for sale rather than continuing to operate it.

Comps and multiples play a role, but the final decision should rest on cash flows.

As a parting comment, I strongly recommend the cash flow valuation team remain unaware of what the comps predict. That comp value produces a reference point and, no matter how unreliable that reference point may be, humans have an irresistible urge to align their work with that reference point. The result is a biased cash flow valuation.


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