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Deal or No Deal?

It all depends on the valuation

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Deal or no deal?

All that’s left to do is determine the market value of the business. Tally the total of the assets. Add up the detailed breakdowns of everything the business owns, including all the equipment and inventory. Subtract the debts or liabilities. And it shows the bottom line.

If it was only that easy! It’s not. Thorough, meticulous, detailed and professional valuations are a vital business art and science.

Savvy business leaders, business schools and valuation professional admit that business valuations are often misunderstood. When it comes to attracting customers, investors or buyers, increasing the intrinsic value of a business is normal practice and crucial. But how do businesses increase that value? What makes the business truly valuable?

The answer is an effective valuation. The key to unlocking an organization’s value, and making it a viable proposition and an attractive commodity that will be sold for profit.

A common valuation myth is that business owners often emphasize the price others will pay for their business.

Valuation professionals caution that it is contrary to the vital view which prospective buyers and investors take. Trends, and history, show that buyers and investors are more focused on the value they will get for their investment. Based on the basic premise that business can be profitable without being valuable. Profits can suffer when one or more variables are changed or removed, but valuable companies are scalable and fully transferable.

“It is way beyond a routine, add-subtract-and-divide mathematical exercise, where we stick the financial statements into an Excel spreadsheet and pop out a value,” says the focused and expert Mike Devonshire, CFO at Calgary’s Petwin Bancorp and a director of the CBV Institute, the not-for-profit organization which governs, accredits and supports the chartered business valuator profession.

“Achieving effective valuations requires really understanding the specific business, the industry it operates in and the general economy, in order to properly value the business.”

He explains the valuation bottom line. “Ideally, a valuation should not only give the business owner a sense of what the business is worth today, but what drives that value and what can be done to add value in the future. I think many business owners think that valuations are just driven purely by the profit of the business. In many cases, other considerations, such as the risk profile of the business and others, can drive value just as much.

“Personally, I think one of the best parts about doing a valuation is meeting the people, hearing the story of the business, and understanding how they compete within their industry. The industry knowledge is also very important. Lots of industries have specific valuation considerations and approaches, so ensuring that the valuator understands the nuances and considerations is crucial.”

Whether it is for common purposes, mergers and acquisitions, tax reorganizations, succession planning, strategic decision-making or other reasons, there is a noticeable Calgary market increase in the need for valuations.

According to Graham Makuk, partner in KPMG Canada’s Deal Advisory practice, “The need for business valuations has increased, driven by various recent reasons. Increased requirements for professional valuation reports from auditors and tax authorities, the increased complexity of transactions and businesses that require an expert’s know-how to navigate and increased market size.

“No longer are businesses only selling to local buyers. There are often international strategic buyers looking to enter new jurisdictions or acquire accretive technology. Like acquiring companies in new jurisdictions to increase market share or get exposure to new customers.”

Devonshire emphasizes other reasons. “An increased demand due to the volatility we have seen in the economy. Between oil and gas volatility and interest rate changes, there is lots going on. Many business owners want to have a better handle on what the value is today, as well as what they can do to increase or protect it in the future.”

Valuation specialists also cite an undisputable demographic factor. As many business owners age, things like estate and tax planning become more of a focus, triggering a business valuation consideration.

There is a consensus, among CVB professionals and business leaders who have benefited from valuations, that thorough, in-depth and effective valuations are a specialty skill combining precision accounting and strategic planning.

“To perform a valuation, it is important to understand the business itself and the broader market that it operates in,” Makuk points out. “Including the industry and economic environments. It is also vital to understand the underlying business operations, the level of maturity and the outlook for the business.

“From a quantitative lens, we need to obtain a financial understanding of the company and understand the expected future cash flows and what return a potential buyer would expect to earn on those cash flows. To properly assess this, we look to public companies, competitions or similar transactions to inform our view on the buyers’ expected return.”

Mike Devonshire underscores that behind the scenes, the valuator must do a lot of work getting up to speed on the business and industry, particularly because they invariably deal with business owners who know both their business and industry.

Despite the owner’s depth of expertise and knowledge, Graham Makuk cautions that the quality of information can be a challenge. “It is not uncommon for the user to not have the needed information readily available or can produce the financial insights needed. This can usually be navigated by the valuator by providing industry tailored insights based on experience or by performing market research and leveraging that to make certain assumptions.

“And deadlines can sometimes pose a challenge. Clients often need a valuation, for a transaction taking place in a few weeks. Depending on the size and scale of the mandate, we typically need three to six weeks to appropriately perform a valuation.” He adds that valuations of new start-up businesses in new industries can also be a bit of a challenge, because there is lots of uncertainty regarding the expected future cash flows and too little available market information to work with.

The protocols and stages of a business valuation, like so many routines and aspects of business, can be an unintentional trap.

The experts agree that one of the biggest speedbumps when presenting a detailed valuation is the use of technical terms, acronyms and jargon. “Many professionals assume that everyone knows what EBITDA is or WACC is,” Devonshire says, “but for most business owners, these are totally foreign terms. Another confusing trap is the use of rules of thumb, without understanding what they mean. Owners will say their friend sold for 4x, but they don’t really know what that means. Was it 4x EBITDA or net income? How was debt treated?”

As an accredited CBV professional, he notes that there is an important education piece that is part of  presenting a detailed valuation, to make sure everyone is on the same page from a terminology perspective.

An effective business valuation is essentially and detailed and complex business plan. A plan which will properly spell out the detailed value of the business or assets. The purpose is to ultimately provide relevant, reliable and valuable information and insights to help the business leader decide.

The decision to buy or sell a business, about how much taxes they will pay in the event of a reorganization, the impact is to their financial statements. A thorough valuation is the make it or break it about a deal or no deal.

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