With our consultancy work in corporate acquisitions, valuations and financings, we at Sophista are daily engaged in thorough analyses of various financial, operational and market factors to determine the economic value of a company. This makes sense, as one of the first questions often asked by clients is, ‘How much is the company worth?’ This is always followed by an interesting conversation about the company, its history, revenue model, customers and the reason and background for the specific question. For us, this is important because we want to know the right context and description of the situation in order to answer the valuation question.
In particular, when a shareholder is being bought out, it is crucial to stress that a thorough business valuation is essential. An inadequate valuation can lead to unfair outcomes, legal disputes or even financial disaster for parties involved. For instance, too low a valuation can lead to frustration and resistance by the bought-out shareholder, which can result in lengthy legal proceedings and reputational damage for the company. On the other hand, too high a valuation can jeopardize the financial health and continuity of the company and harm the interests of other shareholders and stakeholders.
The reasons behind a buyout situation between shareholders can be vary greatly, often accompanies by emotions. These situations can occur either in good harmony or in highly contentious atmosphere. These transactions therefore require not only careful planning and legal alignment, but also a good understanding of the economic value of the company. Once we have aligned on the context and circumstances under which the valuation takes place, we begin calculating the economic value. This involves estimating the expected future cash flows which, taking into account time and risk, are discounted to the valuation moment. Of course, we look at the historical and current position, performance and trends, but the in-depth part is investigating and assessing trends and developments in the market for the business model, the competitive position and the effect on future (growth) potential and cash flows.
Concrete assumptions and assumptions regarding future projections of cash flows are crucial in this respect and require good substantiation. Once we have a good understanding of the company’s value drivers, we can then use several scenarios or sensitivity analyses to show the effects on the business valuation.
Depending on the situation, multiple forecast scenarios of future cash flows may be developedor the impact of changes in key performance indicators, such as higher or lower gross marginmay be made transparent. Sensitivity analyses on the valuation with regard to investments in assets and working capital also often lead to illuminating insights.
It is our experience that this is helpful in the process between parties. It allows stakeholders to see clearly how the valuation is derived and to repond substantively with their own views on the value drivers. This leads to a more balanced process. A well-executed business valuation therefore not only provides an objective basis for negotiations, but also delivers transparency and confidence to all parties involved. It enables shareholders to understand how value has been determined and why certain decisions are made. This forms the basis for fair transactions, trust between parties and maximizing of long-term value for all stakeholders.
This article was originally published in ZAAN Business magazine of March 2024.