Company Valuations: Never an Exact Science

Valuation professionals use several methods and approaches to determine the value of a company, and every transaction is unique, says Weaver’s Brian Reed.

One of the biggest challenges faced by investors and business owners when buying and selling a company is arriving at the proper valuation for the asset. While there are several proven approaches and methods used to assess value, no two transactions are ever the same. 

That’s when a seasoned valuation professional proves invaluable. “The process of determining the appropriate valuation approaches to use in deriving an indicated value of a company generally takes considerable time and experience,” says Brian Reed, Weaver partner-in-charge of financial advisory services.

When it comes to a market approach to valuation, an analyst may value a company using transactions of similar companies, or “market comps,” that occurred in the relevant industry. “Specifically, an analyst may utilize the enterprise-value-to-EBITDA multiple observed in a number of transactions to derive an indicated value for the company,” he says, adding that, based on these multiples, the valuation analyst would estimate an overall value of the company by applying the selected multiple to the company’s EBITDA.

One of the most common difficulties in valuing companies with complex capital structures relates to the rights associated with preferred stock and common stock, and how the value is allocated among relevant shareholders. “The rights associated with preferred shares, for instance, can be categorized as either economic rights or control rights,” he says. The economic rights generally include the following: liquidation preferences, cumulative preferred dividends, mandatory redemption and conversion features. All of these rights could have an impact on the valuation method used and how the value is allocated between preferred and common shares.

While the probability-weighted expected- return method, the option-pricing method, and the current-value method are all effective in allocating a company’s value to the various classes of ownership interests, the most straightforward approach is the current-value method. “It is the easiest method to understand,” says Reed. However, he adds that the AICPA Accounting and Valuation Guide-Valuation of Privately-Held-Company Equity Securities Issued as Compensation says its usefulness is limited primarily to two circumstances: (1) when a liquidity event (an acquisition or dissolution) is imminent and expectations about the company’s future as a going concern are not relevant, or (2) when the company is in an early stage of development where no material progress has been made on the company’s business plan, no significant value has been created for the common equity holders, and there is no reasonable way to estimate the timing or amount of common equity value that may be created in the future.

With greater scrutiny from the Securities and Exchange Commission on how companies are arriving at their asset values, owners are increasingly turning to third-party experts in order to provide more transparent valuations.

This article is published in the 2015 Dealmakers Compendium. This publication is a briefing from Privcap highlighting the deals and commentary from the front lines of private equity.