How do you go about getting the true and fair market value of a business? Whether you’re buying or selling (or investing, insuring or advising!), valuing a company can be a complex and lengthy process, so here’s a more detailed explanation of how it all works.
Firstly, it’s important to know that there are two essential components to the company valuation process:
1: Determining the financial forecasts of the business being valued. This future view is most often provided by the owner or management of the business, and it plays a crucial role in the process.
2: Applying the actual valuation methodology and technical valuation calculations to these financial forecasts that are provided by the business owner (or management team).
Here’s more about these two essential parts.
How does the owner or manager of the business provide accurate information on the status of the company? Financial information includes both historical (past) as well as forecast (future) information. Historical figures are usually drawn directly from the company’s past financial statements. Ideally, these are accurate and audited.
Future forecasts start with historical figures (as they say, the best predictor of the future is the past…). Using past figures to benchmark the company’s current and future performance, basic forecasts can be made by simply extrapolating what the business would look like if past performance continued. Often though, that’s not enough, because businesses change, they pursue new and different opportunities that make future revenue growth rates, profit margins, and reinvestment rates look different over time. Therefore, proper forecasting requires the business owner (or management team) to give their absolute best estimate of how the company will evolve and perform over the next few years, drawing on the company’s latest business plan and incorporating all strategic initiatives.
After incorporating these best estimates, the resulting future forecasts are often “sense checked” (again) against historical figures, to see how reasonable the projections are. For example, if the business grew its revenue at 5% per year for the past three years, then estimating a growth rate of 30% in the financial forecast period is unreasonable – unless there is a compelling and defendable change in the company’s business model to justify doing so.
On this note, here are some other tips to apply to the financial information:
Once historical and future financial information is as accurate as possible, various business valuation methodologies are then applied to calculate the value of the company. At EquityMaven, we use a Discounted Cash Flow (DCF) Valuation as the primary methodology (income approach) and a multiples valuation (market approach) as the secondary approach.
The valuations performed require a multitude of technical inputs that need to be constantly updated (like prevailing interest rates in your country, or market multiples in your industry). EquityMaven makes use of independent sources of market data and derives the majority of this data from Refinitiv (previously branded Thomson Reuters), which covers over 77,000 companies in over 123 markets, representing 99% of the world’s market capitalisation. This is the same source of information that many of the world’s largest and best investment banks use when performing valuations.
As you can see, in order for a company valuation to be accurate, the inputs from the user need to be probable and reasonable, just as much as the technical inputs need to be independent and accurate. Because of this, EquityMaven relies on the user, management or owner to provide the first part…because nobody can know the business better than them.
Assuming this first part is in place, EquityMaven can provide the valuation overlay, using the most widely accepted valuation methodologies and sourcing the technical inputs from the world’s most up to date and reputable sources – providing you with the most robust and accurate company valuation process available today.