Accountants valuation of a business
Discussion
As EricMc has quite rightly said, a valuation *isn't* a valuation in the sense that you can value a used car in the Glasses guide.
There is also the common trap in being 'happier' with a valuation which is larger - rightly or wrongly by a valuer. A lot of estate agents for example get business that way, as they convince the buyer that they are £50k richer then they were before... but the agents know full well *this* will secure the business for them.
If you are looking to sell, then really, honestly, if you think that the accountants valuation should be higher, then price it at the price *you* want.
At the end of the day, you arn't going to sell unless you get a price you are happy with. Also, the buyer certainly aint going to blindly accept your accountants valuation - they probably won't even look at it - and they will do their own valuation bases on their theories which will of course be different again.
There is also the common trap in being 'happier' with a valuation which is larger - rightly or wrongly by a valuer. A lot of estate agents for example get business that way, as they convince the buyer that they are £50k richer then they were before... but the agents know full well *this* will secure the business for them.
If you are looking to sell, then really, honestly, if you think that the accountants valuation should be higher, then price it at the price *you* want.
At the end of the day, you arn't going to sell unless you get a price you are happy with. Also, the buyer certainly aint going to blindly accept your accountants valuation - they probably won't even look at it - and they will do their own valuation bases on their theories which will of course be different again.
As a very general rule, buyers will tend to look at historic results not future results, although there are always exceptions to this. Another big difference will be the multiple that is used on the weighted profits. The best thing is to look at other transactions in your field and see what companies have been selling for. If they have a CF department they should know where to look for this info.
I would think it would matter what the loss in any year was based on, if there was a big move or new expensive machinery purchased etc, as somebody mentioned there probably are different ways to cost a business, im not sure that there are any hard and fast rules though,
More importantly have they explained to you why they have done it this way ?
More importantly have they explained to you why they have done it this way ?
Hi, I'm an Accountant working in the Corporate Finance of a top 10 UK Accountancy firm.
One reason why they may have included the year one loss is to compensate for timing differences between costs incurred and benefit recieved.
For example, if a company spends £1m on advertising in year 1, then launches and sells a service in year 2 onward. Clearly the money spent on advertising in year 1 increases the profits in year 2 onward. Hence it would be wrong to exclude these costs. They should be set off against the later profit to give an overall view of the business.
Normal accounting practice will compensate for most timing differences, e.g. prepayments for say rent etc which is paid during year one for costs in year 2. Similarly if you make capital expenditure it's capitalised and deprieciated to match the cost to the benefit. However, with expenditure such as advertising (for example) the exact value to the business can't ve determined, so it can't be capitalised. The only way to eliminate this timing difference is to aggregate the company's results over several years.
NB, another reason may be to suppress the valuation. Excluding this loss may have resulted in an overly optomistic valuation, and in managing the vendors expectations they will not want to set your sights too high. As others have said, a mathematical "valuation" is merely a starting point for negotiations, and during these negotiations there is normally a fee ratchet for the lead advisors (i.e. advisors to the vendor) such that their fee as a percentage of the transation value will increase as the headline price increases. So there is more than a straight line incentive for the lead advisor to maximise the sale value, although they will not want to leave the vendor with a bitter taste if their initial expectations were set too high.
HTH.
Regards.
One reason why they may have included the year one loss is to compensate for timing differences between costs incurred and benefit recieved.
For example, if a company spends £1m on advertising in year 1, then launches and sells a service in year 2 onward. Clearly the money spent on advertising in year 1 increases the profits in year 2 onward. Hence it would be wrong to exclude these costs. They should be set off against the later profit to give an overall view of the business.
Normal accounting practice will compensate for most timing differences, e.g. prepayments for say rent etc which is paid during year one for costs in year 2. Similarly if you make capital expenditure it's capitalised and deprieciated to match the cost to the benefit. However, with expenditure such as advertising (for example) the exact value to the business can't ve determined, so it can't be capitalised. The only way to eliminate this timing difference is to aggregate the company's results over several years.
NB, another reason may be to suppress the valuation. Excluding this loss may have resulted in an overly optomistic valuation, and in managing the vendors expectations they will not want to set your sights too high. As others have said, a mathematical "valuation" is merely a starting point for negotiations, and during these negotiations there is normally a fee ratchet for the lead advisors (i.e. advisors to the vendor) such that their fee as a percentage of the transation value will increase as the headline price increases. So there is more than a straight line incentive for the lead advisor to maximise the sale value, although they will not want to leave the vendor with a bitter taste if their initial expectations were set too high.
HTH.
Regards.
Edited for spelling
Edited by mrmr96 on Friday 28th December 20:53
Of course factoring in a loss from four years ago is complete nonsense. By that rationale you should request that they also include projections for the next four years to balance it out. A company is worth what anyone is prepared to pay for it – so there’s no ‘correct price’ and three things effect what anyone’s going to pay for it:
1) Return on investment (ie, profit) - Mr Buyer wants his money back! It’s also worth noting that the buyer is only going to get their return from future profits not historic profits. So future projections will be a major factor in a buyer’s valuation. As such, you’d do well to put together a (conservative) two or three year business plan.
2) Commercial risk (or perceived risk, in fact). High risk = low price and low risk = high price. If, for example, a company is reliant on the owner or has one big client, etc..., then clearly this will increase the risk to the buyer – thus reducing value. Net assets also effect valuation because if a company has a high net worth (property, stock, etc,..) this may reduce the commercial risk to the buyer (ie, if the whole things goes belly-up they’re at least left with some assets.)
3) Bidder competition. If you can locate several buyers and get them bidding against each other then you’ll sell for a great deal more than having just one tyre kicker - market forces will always dictate any company’s true value.
Of the above issues, two of them (points 2 & 3) are highly subjective. The third (point 1, profit) is totally objective as far as historic results go but quite subjective in terms of future projections. So two and a half out of three factors are subjective. To base a valuation purely on the historic valuation is, quite frankly, naïve and possibly lazy.
A couple of years ago I was asked to speak at an FT conference about company valuations, along with two other people (who were accountants). I said I’d do it providing I spoke last. The first two chaps spoke along the lines “work out the average (weighted) profit and then apply a multiple (typically 5) to the adjusted EBITDA” – which is the conventional accounting view. When I got up to speak I posed them this question:
Imagine there are two companies both making, say, £500k adjusted profit. You would value both companies at about £2.5m. To which they agreed. I then said company ‘a’ has 200 customers, £1.5m net assets and one moderately interested buyer. Meanwhile company ‘b’ has one client, is reliant on the owner, but is in a great sector and there are ten bidders desperate to buy it. Are the two companies still worth the same? The answer, of course, is ‘no’. Accountants try and value companies but it’s entrepreneurs that buy them - and ultimately an entrepreneur will decide how high they’re prepared to go. Incidentally it will be an emotional decision not a rational one (they fall in love with the idea of owning the company).
1) Return on investment (ie, profit) - Mr Buyer wants his money back! It’s also worth noting that the buyer is only going to get their return from future profits not historic profits. So future projections will be a major factor in a buyer’s valuation. As such, you’d do well to put together a (conservative) two or three year business plan.
2) Commercial risk (or perceived risk, in fact). High risk = low price and low risk = high price. If, for example, a company is reliant on the owner or has one big client, etc..., then clearly this will increase the risk to the buyer – thus reducing value. Net assets also effect valuation because if a company has a high net worth (property, stock, etc,..) this may reduce the commercial risk to the buyer (ie, if the whole things goes belly-up they’re at least left with some assets.)
3) Bidder competition. If you can locate several buyers and get them bidding against each other then you’ll sell for a great deal more than having just one tyre kicker - market forces will always dictate any company’s true value.
Of the above issues, two of them (points 2 & 3) are highly subjective. The third (point 1, profit) is totally objective as far as historic results go but quite subjective in terms of future projections. So two and a half out of three factors are subjective. To base a valuation purely on the historic valuation is, quite frankly, naïve and possibly lazy.
A couple of years ago I was asked to speak at an FT conference about company valuations, along with two other people (who were accountants). I said I’d do it providing I spoke last. The first two chaps spoke along the lines “work out the average (weighted) profit and then apply a multiple (typically 5) to the adjusted EBITDA” – which is the conventional accounting view. When I got up to speak I posed them this question:
Imagine there are two companies both making, say, £500k adjusted profit. You would value both companies at about £2.5m. To which they agreed. I then said company ‘a’ has 200 customers, £1.5m net assets and one moderately interested buyer. Meanwhile company ‘b’ has one client, is reliant on the owner, but is in a great sector and there are ten bidders desperate to buy it. Are the two companies still worth the same? The answer, of course, is ‘no’. Accountants try and value companies but it’s entrepreneurs that buy them - and ultimately an entrepreneur will decide how high they’re prepared to go. Incidentally it will be an emotional decision not a rational one (they fall in love with the idea of owning the company).
Just to add to the post above, this "multiple" idea is a standard technique. But in the example above it has been used incorrectly. To say that the multiple is "typically 5" is, I'm afraid, nonsense. The poster is spot on that there are many more things to consider than just adjusted EBITDA, and these get factored into the multiple which is used. So in the above example one company would be valued on a higher multiple of EBITDA than the other. Exactly what multiple to use is an inexact science. Therefore while the technique of an earnings multiple is far from perfect, it is also far from useless.
Edited by mrmr96 on Friday 28th December 21:33
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