Consulting for the sale of a company - Business valuation
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Why sell a company?
Selling a business can be a strategic decision motivated by a variety of reasons. Owners may choose to sell their business in order to capitalize on favorable market opportunities, maximize the value of their investments, meet personal or business financial needs such as liquidity to fund additional projects or lack of succession to continue the business. Additionally, selling the business may be part of a broader strategy, including restructuring the business portfolio, consolidating the industry, or focusing on areas of greater growth potential. Ultimately, the decision to sell a business may be influenced by financial, strategic, and personal considerations.
There are various reasons why business owners may choose to sell their business, we can divide them into two categories: Personal and work-related.
LABOR | PERSONAL |
Maximizing value | Lack of succession |
Focus on core business | Owner fatigue or exhaustion |
Financial needs | Retirement |
Business strategy | Withdrawal |
Opportunity for growth | Changing priorities |
Changes in the business environment | Conflicts between partners |
Tax benefits | Lack of time |
Business Valuation Methods
There are usually four different methods used to determine the value of a company, and of these, the discounted cash flow method stands out as one of the most used.
- Discounted cash flows
- Multiples
- Book Value
- Mixed or Goodwill
Discounted Flow Method or Cash Flow
Its purpose is to determine the value of the company by estimating the cash flows, that is, the cash flows that can be generated in the future and then to be able to make an appropriate discount according to the risk of the flows.
This method is the only conceptually correct valuation method. In this method, the company is considered an entity that generates cash flows, so to obtain the value of the company, the current value of said flows must be known using the appropriate discount rate.
The value of a company's shares implies its ability to generate cash flows for the owner of its shares, which is why, as we mentioned before, the most appropriate method for valuing companies is this one, discounting the expected cash flows.
This method is based on a detailed and thorough forecast in each period of each financial item associated with the generation of cash flows that correspond to the company's items, such as:; sales collection, labor payments, administrative, sales, etc.
For this valuation, it is necessary to determine a fair and accurate discount rate for each type of cash flow, which is one of the most important points; it must be carried out taking into account the risk, historical and practical volatilities, among other issues.
Formula for discounting cash flows
Where
CF = Cash flow generated by the company in period i
VRn= Residual value of the company in year n
K= Discount rate appropriate to the cash flow risk.
EXAMPLE:
The company TechInnovators SA expects the following cash flows over the next 5 years:
Step 1: General Formula
The formula for discounting cash flows is:
Step 2: Discounting Cash Flows
We use the formula:
Step 3: Discount the Residual Value
We use the formula:
Replacing:
Step 4: Add the Discounted Values
Bottom line
The present value of the company TechInnovators SA is $1,964,545.
This value reflects what an investor would be willing to pay for the company today, considering future cash flows, residual value, and associated risk.
Basic Cash Flows
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Multiples method
Financial multiples are tools that relate the price of an asset to financial aspects of the company, for example, the Price-Earnings ratio (PER) compares the price of a share with its profit share or earnings per share, calculating the division of the former by the latter.
Multiples have the advantage of being intuitive and simple to calculate, but it is crucial to keep in mind that they do not provide all the relevant information.
Valuation based on multiples, especially P/E, is very common in the financial community, but the simplicity of multiples often comes at the expense of deeper analysis that could add value.
EXAMPLE:
ABC SA Company Data:
- Share price: $50
- Earnings per share (EPS): $5
Step 1: Calculate the PER
The PER multiple is calculated as follows:
Replacing the values:
This means that the PER of ABC SA is 10In other words, investors are willing to pay 10 times the company's earnings for each share.
Step 2: Compare with other companies in the sector
To put ABC SA's value into context, it is important to compare its P/E with that of competing companies in the same industry. Let's assume that the following companies in the sector have the following P/E ratios:
Step 3: Estimate the value of ABC SA's stock based on multiples
Now that we know the PER of ABC SA (10) and the multiples of the competitors, we can calculate the Average PER of the sector to obtain a broader reference. To do this, we calculate the average of the P/Es of the competing companies:
Step 4: Apply the average P/E to ABC SA's earnings per share (EPS)
Now we apply the Average PER of the sector (9.67) to EPS of ABC SA to estimate the value of the company's shares. We use the formula:
Result:
According to him multiples method (PER), he estimated value of the action of ABC SA is $48.35.
Interpretation:
- If the market price of the action of ABC SA is $50, this suggests that the action is slightly overrated compared to the Average PER of the sector (which is 9.67).
- If the market price of the stock were below $48.35, would suggest that the action is undervalued relative to its competitors, based on the PER multiple.
Additional considerations:
The multiples method is useful for its simplicity and speed, but it has important limitations:
Comparability: Not all companies within an industry are the same. The P/E does not capture important differences between companies, such as the future growth, he risk wave profitability.
Future evolution: The PER does not take into account the expectations of future growth of the company. A company with high future growth might warrant a higher than average P/E, while a company with little or no growth prospects might have a lower P/E.
Although it is a practical method, the PER should be complemented with other more detailed valuation approaches to obtain a more complete view of the true value of a company.
Main multiples
The Price-Earnings Ratio (PER), Known in English as Price Earnings Ratio, it is a key indicator that relates the value of a company to its net earnings per share. It is one of the most commonly used multiples to evaluate market valuation and determine whether a company is overvalued or undervalued. However, its isolated use has limitations since it does not provide a complete fundamental analysis of the company.
The Price-to-Book ratio (PBR), Also known as Price to Book Ratio, it represents the price of a company's shares divided by its book value per share, it indicates the willingness of investors to pay for a company's assets compared to its book value, and the discrepancy between these two values is linked to the company's growth expectations, the PBR allows to compare the actual book value of a company with its market value, making it easier to assess whether the company's shares are overvalued or undervalued.
Price-Book Value (PBC), also known as Price to Book Value, relates a company's market capitalization to its book value, it can be calculated by dividing the share price by the book value per share. To understand this indicator, it is important to first understand what book value or book value is, this value represents the net worth that appears in a company's accounting records, that is, the difference between its assets and liabilities. It indicates the excess of assets over liabilities, which provides a measure of the company's financial strength.
The PEG ratio, short for Price to Earnings Growth, is the ratio of the Price Earnings Ratio to the Earnings Per Share (EPS) growth rate. For example, if a stock has a P/E of 25 and its earnings are growing at a rate of 25%, the ratio of P/E to growth is 1, meaning the PEG value is equal to 1. This indicates that the stock is fairly valued in terms of growth. However, this is an oversimplification - a PEG equal to or less than 1 could indicate fundamental undervaluation, while a PEG greater than 1 could suggest overvaluation. It is important to note that the PEG, like the P/E and other metrics, is relative and should be compared to stocks in the same sector or the market average, as well as to development and earnings expectations.
Book Value Method
The book value method is a technique used to value a company or asset based on its value recorded in the accounting books, instead of considering factors such as market value or future income generation potential, this method focuses on the accounting values reported in the company's financial statements, such as the balance sheet.
In essence, the book value method takes into account the company's assets, liabilities and net worth as reflected in its accounting records, It typically involves adding up the company's tangible and intangible assets and then subtracting its liabilities to determine the net book value, This value may be used as a benchmark for valuing the company, but may not necessarily reflect its actual market value, especially if assets are overvalued or if there are liabilities not reflected in the accounting books.
The book value method is most commonly used in situations where the company's assets are easily quantifiable and are not expected to change significantly in the near future, however, it may not be suitable for companies with high-value intangible assets, such as trademarks or intellectual property, whose actual value may differ significantly from their book value, in such cases, other valuation methods may be more appropriate.
There are other business valuation models that are based on financial statements such as:
- VAdjusted book value: To address the discrepancy between book value and actual value, this valuation method is developed which aims to calculate the net worth of the company considering the actual value of its assets and liabilities.
- Liquidation value: The liquidation value of a company corresponds to the amount obtained from the sale of its assets to settle its debts and proceed with its closure or liquidation.
EXAMPLE:
Company Data «TechInnovators SA»:
Step 1: Determine Net Book Value
The net book value of the company is calculated as:
Step 2: Interpretation of the result
He book value reflects what the company has recorded in its accounting books, based on its assets and liabilities. In this case, the net worth is $400,000, which is the value that the company's shareholders have in terms of net assets.
Considerations of the Book Value Method
- This book value does not necessarily reflect the market value of the company, as it does not consider aspects such as the value of intangible assets (for example, intellectual property or brand) or the potential for future income generation.
- This method is more appropriate for companies with tangible assets of significant value, such as real estate, machinery or equipment, and less useful in companies with intangible assets valuable.
- Book value can also be affected if assets are overvalued or if the company has hidden liabilities not reflected in its accounting records.
Adjusted Book Value
In some cases, to obtain a more realistic value of the company, an adjustment to the book value, known as adjusted book value, which takes into account the actual value of assets and liabilities. For example, if the company has intangible assets with a high market value (such as a valuable brand), that value could be added to the accounting assets.
Liquidation Value
He liquidation value Liquidation value is used in scenarios where the company is in the process of closing or liquidating. This value is calculated by taking the company's assets and selling them to settle debts. Liquidation value is generally lower than net book value, as assets are often sold below their book value in a liquidation.
Bottom line:
The book value of TechInnovators SA, based on its balance sheet, is $400,000. However, this value should be taken with caution, as it does not reflect the market value or the potential of the company in the future. Other valuation methods, such as the discounted flow method (DCF) or the multiples method, may be more appropriate to obtain a more accurate estimate of the true value of the company.
Mixed method or Goodwill
The mixed method, also known as the goodwill method, is a business valuation technique that combines different approaches To determine the value of a company, this method considers both tangible and intangible assets, such as brand reputation, customer loyalty, intellectual property, among others. By incorporating these elements, the mixed method seeks to offer a more complete and accurate assessment of the value of a company.
Being an intangible asset, goodwill is distinguished by including values that are not recorded in the accounting books.
Examples of Goodwill could be:
- Reputation in the market
- Trademark Ownership
- Knowledge and skills of staff
- Loyal customer base
Thus, these intangible assets contribute additional value to the overall price of the company, which motivates the buyer to anticipate long-term benefits to justify their investment.
EXAMPLE:
Company Data «TechInnovators SA»:
Suppose that TechInnovators SA is being acquired by a larger company, and the mixed method will be used to value the company. Consider the following data:
Step 1: Determine the book value of assets and liabilities
First, we calculate the net book value of the company, adding the tangible and intangible assets and subtracting the liabilities.
In this case, the net book value of TechInnovators SA is from $500,000.
Step 2: Incorporate Goodwill (Value of Intangible Assets)
He goodwill represents the additional value assigned to the company for intangible assets not directly reflected in the accounting records, such as brand reputation, the loyal customer base or the staff knowledge.
In the case of TechInnovators SA, goodwill is estimated to be worth $100,000 due to the following factors:
- Reputation in the market: TechInnovators has a strong presence in the technology industry, and its name is widely recognized.
- Loyal customer base: It has a recurring customer base that ensures stable long-term income.
- Intellectual property: The company has highly specialized software that gives it a competitive advantage in the market.
Step 3: Calculate the total value of the company using the mixed method
The total value of the company, according to the mixed method, is the sum of the net book value of assets and liabilities plus the value of goodwill.
Interpretation of the Result:
The estimated total value of TechInnovators SA using the mixed method either goodwill is from $600,000. This value takes into account both the tangible assets (such as equipment, machinery and software) such as intangibles (such as brand, intellectual property and customer base).
- Tangible assets: $600,000
- Goodwill (intangible assets): $100,000
- Total value of the company: $600,000
Mixed Method Considerations:
- Advantages:
- The mixed method allows for a more holistic view of the company, since not only what is in the accounting books is valued, but also its intangible value.
- It is useful for companies with significant intangible assets, such as innovative technology, loyal customer base, or recognized brands.
- Disadvantages:
- Determine the value of the goodwill It may be subjective, as it depends on the interpretation of the quality of intangible assets.
- It does not always reflect the actual market value of the company, especially if intangible assets cannot be accurately valued.
Bottom line:
He total value of TechInnovators SA, using the mixed method or goodwill, is from $600,000. This value reflects both the tangible assets like the intangibles, allowing for a more complete assessment of the company.
Preparing for a sale: What should you do before selling?
Before the sale it is necessary:
Analyze the decision behind your sale
Before starting the process of selling your company or business, it is essential to take a moment to reflect and analyze the reasons behind the sale, as well as the personal or professional goals you want to achieve with it. This exercise will allow you to structure an effective transfer plan.
In addition, it is essential to keep in mind that potential buyers of your business, whether entrepreneurs, investors or others, will want to know all the details of the company; any lack of clarity or inaccuracy could generate distrust and lead the potential buyer to withdraw from the process.
Always remember that trust and transparency are essential to the success of this process.
Plan the strategy
Before embarking on the sale of your company or business, it is crucial to establish a solid strategy and avoid the common mistake of starting this process without adequate preparation. There are multiple aspects that you must take into account before starting the sales process, including legal, fiscal, labor considerations, among others.
If you intend to sell, it is crucial to carefully plan the transfer, this involves keeping impeccable accounts and ensuring that all accounts are in order.
It is advisable to take the time to keep a detailed record of each expense, income and inventory, because as we mentioned above, if your goal is to find the right buyer for your company, it is very likely that they will want to thoroughly examine all of the business's financial data before making a decision.
Preparing for change and departure
Before proceeding with the sale of your company or business, it is essential to prepare your employees so that they can carry out their responsibilities efficiently even in your absence, which will add value to your company or business.
When the time comes to sell, it is advisable to appoint a trusted employee who has experience, skills and time with the company to handle the daily operations. This employee can play a key role in ensuring a smooth transition, as they know the processes, customers, as well as the strengths and weaknesses of the company.
Before you leave, make sure each employee is well trained and able to carry out their duties independently, without relying on an authority figure.
Present your employees as a valuable asset to your business. One of the main advantages of acquiring a running business is that from the first day of sale, the business continues to generate income.
Legal issues
Naturally, this involves examining the contracts currently in place – while some contracts may be transferable, such as employment contracts, others may not be, especially if they were not drawn up in the name of the company. This requires understanding the implications of leaving the company and communicating to the buyer all the responsibilities they are assuming by acquiring it, as well as the consequences of not fulfilling them.
Increase the company's sales
Another important tip before selling your company or business is that having a solid cash flow makes it much more attractive than those with lower sales. This aspect will serve as a reference point for potential buyers, as it indicates the demand for your products or services and will also inspire confidence in the long-term profitability of the business.
Therefore, it is advisable to plan a strategy that may include the start of a digital marketing campaign, the launch of new products or the improvement of services. It is also beneficial to focus on expanding the customer base.
Professional advice
This advice is crucial and requires special attention when selling your company or business. It is essential to understand that finding the right buyer and negotiating with them is a task that takes a lot of time and involves risks. Therefore, the most appropriate option is usually to hire a professional who will assist you in the search, defend your interests, provide their experience as an expert negotiator and guide you throughout the entire process, as well as guide you in concluding the appropriate and fair value of your company.
Filter and select buyers
Not everyone interested in buying your company is a suitable buyer, so it is crucial to be cautious when looking for the ideal buyer and verify that each offer comes from someone responsible and with good intentions. An important step in selecting the right buyer is to prequalify the interested parties, which will allow you to identify the most viable and favorable proposals and in this way filter them and discard some.
It is recommended to consider several potential buyers so that you have alternatives in case a negotiation does not come to fruition, which can speed up the sales process.
Before sharing information about your business, it is essential to confirm that the buyer has the ability to obtain financing.
It is important for potential buyers to sign a confidentiality agreement to protect your company's confidential information.
Reliability
It is important to be careful and make sure not to make the transaction public before the sale is formalized, because if the sale is not completed, potential buyers may have doubts about the quality of your business, making the sales process more difficult and delaying.
That is why one of the most important points is to consult with a professional on the subject, who will know how to carry out the process while maintaining confidentiality.
What can affect the sales process?
Once the company is ready for transfer, it is crucial to proceed with extreme caution during the negotiation process. The buyer will require complete and accurate information about the company. Tampering with this information could result in a defect of consent that would void the transaction, in compensable damages and, in extreme cases, even in a crime of forgery of documents.
However, the company cannot provide its confidential information without protection, therefore the due diligence process aimed at auditing this information must be safeguarded by appropriate confidentiality clauses.
It may be prudent to seek outside advice during this process, including appraisers, independent auditors and possibly a sales team.
Of course, the participation of potential buyers will require additional precautions, as will the purchase offer. These precautions may include the creation of guarantees, such as insurance, guarantees, deposits, bonds, among others. The selection of the most appropriate instruments will depend on the specific circumstances of each case.
Therefore, it is advisable to have a legal team before proceeding with the sale of a company. This team should include professionals specialized in legal, tax and business areas.
Identification of Potential Buyers
Finding potential buyers for a company can involve a variety of strategic approaches and specific tactics.
By combining different approaches and strategies, you can expand your options and increase your chances of finding potential buyers interested in acquiring your company.
Market research | Professional networks | Financial intermediaries | Advertising and marketing | Events and conferences |
-Market analysis – Competitor analysis for potential buyers | -Contact colleagues, trade associations, investors, financial advisors and other experts in the field. | – Investment banks, business brokers or financial advisors | -For promotion | -Participate to connect with potential buyers |
Competitor Research | Online platforms |
-Investigate similar competitors who may be potential buyers | -Specialized platforms for sales and promotion |
Negotiation and Favorable Agreements in the sale of companies. How to do it?
Negotiating and obtaining favorable agreements in the sale of a company requires strategic skills, patience and a deep understanding of the objectives and needs of both the seller and the buyer. To achieve a successful negotiation, it is essential to prepare thoroughly, understanding in detail the assets, liabilities, strengths, weaknesses and future projections of the company, and establishing clear and realistic objectives for the sale. In addition, understanding the market in which the company operates and making an accurate valuation are key steps to support arguments and avoid discrepancies. Identifying negotiation points, maintaining effective communication and focusing on mutual interests are essential elements to reach satisfactory agreements. Flexibility, creativity and the support of professional advisors are also important to navigate the negotiation process successfully. By following these steps and maintaining a collaborative approach, you will increase the chances of obtaining favorable terms in the sale of your company.
Maintaining Confidentiality
Maintaining confidentiality during the process of selling a company is crucial to protect the reputation, stability and value of the business. Before sharing any confidential information about the company with potential buyers, it is essential that they sign a confidentiality agreement, limiting access to confidential information only to authorized individuals necessary for the sale process.
Use secure methods of communication, such as encrypted emails or secure virtual rooms, to share confidential information with potential buyers and advisors, carefully evaluate the suitability and credibility of potential buyers before sharing confidential information, keep employees informed about the sale process in a limited and controlled manner to avoid leaks of confidential information, establish procedures to monitor compliance with confidentiality agreements and take prompt and appropriate action in the event of any breach or leak of confidential information.
Maximizing Enterprise Value
Maximizing the value of a company for sale involves a series of strategies and actions aimed at increasing its attractiveness and income-generating potential. These strategies include financial optimization, which involves improving the financial health of the company by reducing unnecessary costs, cash management and maximizing profit margins. In addition, it is crucial to develop and implement sustainable growth strategies, such as expansion into new markets and revenue diversification, improving the quality and value of the company's assets, implementing efficient management practices, investing in brand and reputation building, and maximizing the customer portfolio are also fundamental aspects.
Finally, conducting a thorough assessment of the company to address any weaknesses before beginning the sales process is essential to maximizing its value.
Continuous support during the sales process Who can help you?
To sell a company, you can seek help from business brokers, mergers and acquisitions lawyers, financial advisors, business valuation specialists, business strategy consultants, and marketing and public relations professionals. These experts can provide you with specialized advice and services in key areas such as finding potential buyers, negotiating terms of sale, company valuation, strategic planning, and promoting the sale. Depending on your specific needs, you can count on one or more of these professionals to facilitate the process of selling your company successfully.
