How Do Buyers and Sellers Determine a Company’s Worth?

Price is one of the most exciting factors in mergers and acquisitions. Buyers think about the potential synergies and revenue that a strategic acquisition can bring to their firm while owners are motivated by a big pay day from selling.

In order to determine price, buyers and sellers use valuation, a set of established procedures, to determine a company’s worth. Although valuation provides a baseline for the price of the acquisition, it is not the same as price because  a number of non-financial factors including deal structure, employee agreements, or other perks can affect the dollar value of the deal. Valuation is both an art and a science because it takes preparation, thought and experience to select the appropriate methodology and incorporate the correct assumptions.

There are three common valuation methodologies: the asset approach, income approach, and the market approach.

  1. The asset approach is commonly used to value a non-operating business or a business that continues to generate loss produces a floor value and is typically used as a “sanity check.”
  2. Two common income approaches are the capitalization of earnings and the discounted cash flow (DCF). These approaches are used for profitable and stable businesses.
  3. The completed transaction method and the guideline public company method are two market approaches. In the completed transaction method, the business is compared to companies that have been sold in order to establish a baseline and in the guideline company method the business is compared to a set of public companies with similar characteristics.

Each of the approaches listed above come with their own set of assumptions and can be used for a variety of purposes including tax and estate planning, accounting, strategic planning and mergers and acquisitions. Understanding the assumptions and the purpose of valuation is critical in selecting the right approach because the it is possible to calculate multiple values for the same company. And because buyers and sellers have different perspectives and assumptions, they usually arrive at different values.

Learn more about business valuation for mergers and acquisitions in our upcoming webinar “The Basics of Business Valuation” on September 21, 2017.

The Basics of Business Valuation

Date: Thursday September 21, 2017

Time: 1:00 – 2:00 PM EDT

Photo Credit: OTA Photos via Flickr cc

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