On Business Valuations and Business Strategy

What is a valuation all about and why is it done?

Answer: A valuation consists of analyzing a company from the point of view of its strategy, markets, and competitive advantages in order to establish its fair market value. Several different methodologies are employed in this exercise, the result of which is to inform the business owner (1) what the key determinant(s) driving the value of his/her business is/are; and (2) provide a starting point to argue for the highest price per share when negotiating with potential investors. We have written a special guide for company owners all about valuation. [ our guide ]

Does Osprey perform business valuations upon the request of clients without a transaction resulting?

Answer: Certainly. A valuation of the client’s company is frequently prepared as part of the process of understanding where value is generated and how it can be improved. Sophisticated company owners use this as a planning device in order to confirm, or to make modifications to, their business strategy. In addition to implementing strategic planning and monitoring processes, companies also use it to determine how best to finance their business (referred to as “capital structuring”). In this way they maximize shareholder value.

The decision whether to proceed to a sale of shares of the company is an independent one. Whether a sale follows depends on the interest of the market, the realistic conditions that can be obtained and, of course, the final decision of the company owner, based on his overall priorities.

What methods are used in the valuation?

Answer: Typically, a Discounted Cash Flow (DCF) method is employed, as it addresses most directly the particular revenue, expense, operating margin, capital spending and working capital profiles of the company being valued. In addition, one analyzes the company by comparing it to similar companies with respect to the relationship between value and level of sales and other earnings-based indicators (for example, EBITDA -- earnings before interest, taxes, depreciation and amortization). Finally, a search is performed for similar transactions to determine at what price such companies have been bought or sold in the recent past.

So a company owner can find out on what terms and prices other firms from his same field of activity have been bought or sold?

Answer: Yes. Osprey typically does extensive research to find out this kind of information based on public sources and private industry contacts. Providing clients with information about similar transactions and companies (subject to ethical and legal limits of confidentiality) and relevant industry indicators is a normal part of our work for clients.

Which are the key things an investor seeks? Prior to exit, is it necessary to sign a contract? If so, for what period of time?

Answer: This depends on the particular circumstances. The Shareholders’ Agreement is critical in defining the major conditions an investor expects in order to protect his investment. They typically serve to ensure that the new investor ranks “pari passu” with the owner (i.e. sharing of risks in proportion to their shareholdings) and that there is commitment to implementing specific strategic actions (as previously discussed and agreed) to grow the company’s value.

Exit conditions are also mutually agreed in advance. For example, an investor can agree not to sell his shares to a third party without offering them to the company owner first (right of first refusal) or to sell his shares together with the company owner in proportion to their shareholdings at the same price.

Are there big differences between different valuation methods? If so, what causes these differences?

Answer: There can be significant differences and an exhaustive description would fill a textbook. A key mistake many people make is to focus on static asset values and their historic cost, as opposed to what these assets generate in terms of operational cash flow. We spend a lot of time examining these distinctions with a view to determining fair value. At the end of the day, value is whatever someone is willing to pay for a company or asset.

How does Osprey put a value on investments in intangible assets, such as information networks, advertising, promotion, software and good commercial positioning.

Answer: One doesn’t usually value these items directly; however, the Discounted Cash Flow method (DCF) and other methods capture their value through the financial returns they generate.

Tell me more about “Maximizing Shareholder Value”!

Answer: I thought you would never ask. Using Company Valuation as the measuring stick of the success of corporate strategy has gained considerable acceptance in the past 20-25 years. Indeed, it is hard to open any Annual Report of a listed company these days without reading introductory statements such as “we have delivered on our promise to deliver value to shareholders” or “the return to shareholders puts us in the top quartile of NYSE performers”.

Also increasingly important to investors is the fact that focusing on Shareholder Value has been shown empirically to maximize outcomes for all other stakeholders. Thus in an age where value is affected by policies towards corporate governance, transparency, environment and interaction with local communities it pays to focus on Shareholder Value!

Those (business) cultures that have embraced Shareholder Value as the overriding metric for company strategy making, notably the US and UK, have economically outperformed those that have not. By performing a valuation, companies can “benchmark” themselves. The methods know no boundaries and can be applied just as easily in developing as developed economies.

At Osprey we apply ‘shareholder value measurement’ as a key part of a strategic planning project. It is a powerful tool for business owners and helps focus on a results oriented project.