Valuation & Negotiation – Art and Science, Bengaluru

What would someone expect to do on a Saturday afternoon? Well, some might prefer to watch a movie, while some might choose to spend time with their loved ones, and others might opt to learn something that they truly value. For the latter class, the Indian Association of Investment Professionals (IAIP) Bengaluru had the honor of hosting a workshop on Valuation & Negotiation – Art & Science presented by Mrs. Anjana Vivek, Founder and Director of VentureBean Consulting Private Limited, a company that focuses on Management Consulting. The event held on June 22^nd 2013 was well received by the members.

The interactive discussion began with a set of thought provoking questions from the speaker:

• What do you think of when you hear the word valuation for a business?
• Why do values of companies change from time to time?
• How can a company which is continually losing money have any value?

Anjana helped the audience understand these questions with the help of live situations.

How to Value a Company:

Valuation is a very subjective exercise and the perception of a company’s value could change substantially between a buyer and a seller. Also, the purpose of buying and/or selling would be a deterministic factor in deciding upon the premium or discount for the subject company. The reasons for such differences in value could be due to multiple factors. Some of the key factors include but are not limited to assumptions used in determining the value of the company, perception of risk of business, the stage of business, promoter’s background and the desperate need for funds. These are factors which has implication on one’s decision to decide a value for the company and why someone is ready to pay more than others.

A company can be valued through certain methods. A broad categorization of the commonly used methods is:

1. Cost Based– Value conclusion from this method is also known as book value, replacement value and liquidation value. This method is considered when there are concerns over company being a going concern or company not having significant operations. This method doesn’t provide with an appropriate value of a company because value of going concern lies in revenue and cash flow it will generate in the future.
2. Income Method– This method is also known as earnings capitalization method, profit earning capacity value method and Discounted Cash Flow Method (DCF). These methods are useful to value companies that are expected to have a stable cash flow / profitability. The biggest disadvantage of this method is that both profits and cash flows need to be predicted for the next few years and then discounted back to date. Projecting cash flows over next few years require some assumptions to be made which become very subjective after certain point of time.
3. Market Based – This is a relative valuation approach, where the value of a company is determined in relation to the value of a similar company. Some of the frequently used ratios to value a business under this method are enterprise value (EV) to earnings before interest, tax, depreciation and amortization (EBITDA), EV to revenue, price to earning etc. The greatest challenge to ensure appropriate valuation of a company by this method is in the choosing of the right method and finding out comparable company which is similar to the subject company in terms of products, size, profitability etc. This method is useful to value a company when cash flow and earnings of a company is negative.

Anjana showed the audience certain valuation models and explained the significance of certain critical factors such as Internal Rate of Return (IRR) and projection of cash flows.

Practical Considerations

Value of a company is not only based on quantitative modeling but also more importantly on qualitative aspects. These qualitative factors play an important role in concluding the final value of the company in the negotiation stage. Following are few of the important qualitative points that were debated and deliberate upon:

• For an agreement on the pricing of the deal, a consensus on the assumptions between the buying and selling parties must be reached. This is predominantly based on the perceived risk of the parties apart from demand and supply bottlenecks.
• The importance of due – diligence for the successful completion of a deal is extremely critical. Most concerns, both business and regulatory, are identified during this stage.
• To be successful in closing deals, it is extremely important to be able to negotiate the correct price. This would include due considerations for non-financial parameters apart from issues that were identified as part of the due – diligence process.
• The cost of capital differences between the buying and selling differences would normally result in significant differences in business valuation. Further, the cost of capital for the business should be reliably estimated.
• In most cases non-financial parameters such as board position / representation, expertise, distribution of control and quality of the selling entity with respect to employees, clients, and company management play a more important role than financial parameters in determining business value.
• Valuation of intellectual property including brand, goodwill, patents, websites and trade names become crucial in today’s world. Ceteris paribus, value of a company having intangible asset would be higher as compared to a company which doesn’t have any intangible asset.
• In a business acquisition, the cultural aspects of the buying and selling entities play an important role in ensuring a successful takeover.
• Based on various studies, it is observed that the buyer normally overvalues the potential synergies in the deal resulting in over-pricing the deal. In most real life situations, the deal does not succeed due to this reason.

The discussion was concluded with an elaborate Question & Answer (Q&A) session with Anjana clarifying various aspects of valuation that were raised as part of this session.

Some of Anjana’s popular presentations and documents are available at www.slideshare.net/anjanavivek.

Contributed by: Hareesh Mothi CFA and Deepak Mundra CFA