Company valuation as a basis for purchase/sale

The topic of “company valuation” often stirs the emotions. In particular, shareholders of family-run companies often see a higher value in their companies than the figure actually reveals and that can be achieved on the market. This is due to the fact that a family history and one’s own life is connected with the companies. Family entrepreneurs see their success reflected in the value of the company.

The value is what you get, the price is what you pay for it. Value can be perceived differently for different people or businesses.

Example: For a prospective buyer who can tap into interesting synergy potential in combination with his existing business through a purchase, the value of a company to be sold may be higher than for another prospective buyer who would run the company as a stand-alone entity. The purchase price would be the same for both prospective buyers, although the first will have a higher willingness to pay.

Therefore, it is important for business owners and managers looking to sell a business or company to understand what qualities make up the value from a buyer’s perspective.

As long as you do not know any concrete prospective buyers whose strategic or operational interests you can bring into the valuation, your only option is to determine an objective value, which can then be used to interpret a realistic purchase price range.

Depending on the intended use, this objective value is determined differently. The focus is always on the benefit accruing to the shareholders from the company after taxes.

An operating company for which it is assumed that business operations will continue (“going concern”) is valued on the basis of the financial profits which the company generates and which can be distributed to the shareholders. Two methods have become established for this purpose: the capitalized earnings valuation method, and the discounted cash flow method. The multiplier method is widely used in practice, but lacks methodological foundation.

A closed-down company is valued using the liquidation value method on the basis of the sum of the values of all assets. The assets are determined using the net asset value method. Trademarks and industrial property rights can also be valued.

Valuation guidelines can be found in the standard IDW S1.

The price of a company, a business operation or a business is developed in the course of negotiations. The price is the exchange value that you can achieve for your company at a certain point in time under certain conditions. This price may well differ from the value.

Example: For publicly traded companies, the price is exactly the number of all shares multiplied by the share price. This is the market capitalization. At any given moment, it represents how much market participants are willing to pay for shares of the company, the stock.

This is not so simple for a company that is not listed on the stock exchange. However, comparisons with listed companies can help to make the calculated value of a company more plausible.

Example: An unlisted, medium-sized company reliably generates an EBIT of 15% of its sales of 30 MEUR, i.e. 4.5 MEUR. A listed company in the same industry generates an EBIT of 7.5% of its sales of 5 billion EUR, i.e. 375 MEUR. From the listed company we know that the market capitalization is 2 billion EUR. The ratio of the market capitalization to the EBIT is 5.333. The value of the listed company is therefore 5.333 times the EBIT figure.

Transferring this to the unlisted company, we can assume that the enterprise value is 5.333 times the EBIT of 4.5 MEUR, i.e. 24 MEUR. Because this is a smaller company and because the fungibility is not the same as for a listed company, appropriate deductions are justified; but at least we obtain an order of magnitude for a reasonable company value with a simple comparison procedure.

Such comparison procedures can also be used if it is known for what price comparable companies have traded. However, it is difficult to obtain such information, which is often confidential. In this case, you will have to rely on arithmetic methods that use either earnings as the basic variable or cash flow.


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