No one wants to overpay for an acquisition, and every business owner wants to achieve the highest price possible. But how should a buyer go about putting a fair and accurate valuation on a business without going in so low that the deal is scuppered?
Valuing a business comprises elements of art, science and judgement, says Stephen O’Flaherty, partner, corporate finance, BDO. “Professional business valuers firstly gain a thorough understanding of the target business and then leverage this knowledge with understanding the key value drivers of the business to determine market valuation metrics, for example, earnings before interest, taxes, depreciation, and amortisation (EBITDA), before determining an appropriate value for the business in question.”
The valuer will typically apply a number of valuation approaches as part of their work, including the market approach or earnings method to arrive at his final position, he adds.
“By providing this knowledge to prospective buyers, they in turn are armed with up-to-date relevant information,” says O’Flaherty.
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Buyers usually anchor their valuations on common metrics used for similar businesses, says Grit Young, EY Ireland partner and technology, media and entertainment and telecommunications leader. “An easy example where a complete rethink might be required, would be a software as a service (SaaS) business that often attracts valuations that assume that existing customers are locked in.
“Those businesses often attract multiples based on annually recurring revenue and many costs. If evidence comes to light that customers can switch easily, the valuation approach and the comparable/similar business list drawn up by the buyer is called fundamentally into question.”
The buyer may then draw up a different list of comparable companies and transactions to gather multiples or discount rates, IRRs (internal rates of return) and will probably base those multiples on historic or next 12 months EBITDA rather than revenue or annual recurring revenue (ARR), explains Young.
If there is a concern with regards to the achievability of projections, then earn-outs or deferred contingent consideration can be effective, says O’Flaherty. “The use of such structures is applied to incentivise sellers to stay on with the business post-acquisition and reward strong post-deal performance, with payments becoming largely self-financing for the purchaser.
“However, caution must be applied when determining the level and terms of earn-outs and deferred consideration so as to ensure the terms agreed to are appropriate with advisors engaged to ensure requisite safeguards are in place to direct future payments.”
External advisors can play a key role on both the buy and sell side of a deal, says Young. “Advisors are typically tasked with a certain set of diligence procedures which can entail financial, tax, HR, IT and commercial. The buyer will not always commission extensive procedures and might limit the diligence to red flag reports.
“It is always easier to stress-test assumptions – either internally or through an external advisor – when the scope of the diligence is comprehensive. Increasingly we are observing commercial diligence focus on the impact AI might have on the business.”
As a valuations partner, Young says she would argue that buyers should obtain independent, professional advisors that have a formal role in stress-testing assumptions as standard, but this is not always the case in Ireland.
“Buyside valuations, when the buyer is a trade buyer and there are no external debt providers, are often rushed and high level.”
Valuation can be revisited at any stage, says O’Flaherty. “Obviously however, any unwarranted or unsubstantiated return to valuation post signing of HOTs (heads of terms) will jeopardise the deal but where warranted, perhaps due to the unearthing of risks or adverse findings during diligence, revisiting valuation can be appropriate.
“The key is to address this in the right way with the sellers. Strong communication and rationale are key along with adopting a commercial and sometimes innovative approach to finding workable solutions such that the deal can proceed. For example, deferred contingent consideration can often represent a workable solution for both parties. Your advisors should be able to guide you through these negotiations whilst ensuring a strong working relationship between the buyer and seller is maintained.”
