When determining a value for a company, is it permissible to use a multiple instead of a long, formal valuation?

Q: When determining a value for a company, is it permissible to use a multiple instead of a long, formal valuation?

A: Merely using a multiple is not a practice that is allowed by the IRS or other valuation professionals. An arbitrary multiple (such as 3, 4or even 7) used against an arbitrary number such as tax profits or financial profits will yield another arbitrary and useless number. To get a good, solid value, a business owner must rely on trained professionals to get a value that is acceptable and defensible.

The Importance Of A Strong Balance Sheet

Most M&A experts agree that the ultimate transaction value of any profitable, on-going business is largely determined/influenced by its cash flow, which is most frequently expressed as its adjusted, or normalized, earnings before interest, taxes, depreciation and amortization (EBITDA). If that’s the case, why should we be at all concerned about the strength of the company’s balance sheet?

In point of fact, the role of the company’s balance sheet in the M&A valuation process is not well understood –even by most M&A professionals. Recognizing that in almost all cases the buyer will need to re-engineer the company’s debt in order to finance the acquisition, most M&A advisors spend little time analyzing the seller’s balance sheet (interest rate) than equity, a company with a strong balance sheet can typically command a higher purchase price, and still meet the buyer’s expectations for the return on his equity investment.

In reality, the strength of the company’s balance sheet, particularly as it relates to the collateral value of the company’s assets, plays an important role in determining just how much bank debt the business will support, which in turn affects how much cash equity the buyer will have to invest to finance a particular purchase price. Since bank debt typically has a much, much lower return expectation on equity, a company with a strong balance sheet can typically command a higher purchase price, and still meet the buyer’s expectations for the return on his equity investment.

It is principally for this reason that manufacturing businesses typically sell for a higher multiple of cash flow than a distribution company, which in turn sell for a higher multiple than service companies.

If you know of a business owner who’s thinking of selling or buying a business and who might benefit from a free consultation with us, have them contact me, or any of the M&A professionals at www.bradwaygroup.com

Mike Ertel, CBI, M&AMI
The Bradway Group
813.299.7862 Direct

©2008, J. Michael Ertel, PA

Why are valuation discounts for minority shareholder interests illegal in some states?

Q: Why are valuation discounts for minority shareholder interests illegal in some states?

A: In most states, laws exist for the purpose of protecting minority shareholders against the majority interest shareholders. A sweep of corporate case law plainly reveals that many situations have occurred where the minority shareholder has been taken advantage of by the majority shareholders. State laws, including those not allowing minority shareholder discounts, have been written to help prevent squeeze outs, freeze outs, and shake outs. When valuing a company in these states, it is important for the appraiser to be aware of the laws and plan and create the valuation accordingly.