How I thought about transactions yesterday – and today
M&A transactions are one way for shareholders to create and exploit value. Values are not only created when new shares are issued and fresh capital raised, driving future growth, but also when selling a minority stake to a strategic investor, whose ressoures may then be employed on various levels.
Value is exploited when shareholders sell their entire stake. Everything one ever wanted to achieve has then be achieved. True – if many entrepreneurs were not interested in the future of their company regardless of any shareholder status. In addition there are several options for former shareholders to benefit from the future development of the company, even after the organisation was sold.
For most readers it will be rather obvious that valuation issues play an important role in any transaction, regardless of “creation” or “exploitation” considerations.
Correspondingly the various methods to assess company valuation take up significant space in corporate finance blogs. I certainly got excited about discounted cash flow-, market- and multiple oriented methods and on how to reconcile the usually diverging results back in the days myself.
But is that indeed a crucial transaction related topic or just a welcome opportunity for the adviser to highlight his astuteness and competency. The answer depends also on the case in question.
Actually all methods hinted at depend on parameters such as revenues or the various profitability definitions after costs. Which are of course available only to a lesser degree at an earlier stage of company development (thinking about a strongly investing or even pre-revenue startup). Which is no absolute obstacle, a credible Forecast can be worked on.
At a later stage there is usuallly plenty of parameters that may be used for valuation purposes, celebrating all aforementioned methods and more. The necessary data are gathered in the course of the financial analysis and planning to a large degree anyway.
Hence there is really no objection against valuing companies, neither at an earlier nor at a later stage and yes, one should have dealt with the topic, even though valuations are not useful in the sense that the results can be presented to an investor as objective truth, forgoing negotiations.
And yet the fixation on company valuations in the context of company transactions is rather wrong than right. Successful transactions are always the result of a certain circumspection (as well as of circumstances that one can not influence alone). And circumspection involves a whole range of factors that have little to do with agreeing on valuations alone.
In a broader sense the necessary foresight includes topics such as the potential buyer/ investor, its shareholder structure, consensus on the parameters of the transaction in question, reliability, assessable long before any LOI is signed, long term strategic vision and potential short term tactic motives for analyzing the specific market segment of the target company. Some of these questions are trivial, others not that much, but all contribute to the likelyhood that committments made, whether signed or not, are honored.
Closer to the topic of company valuation, but addressed far less often: the structure of the transaction. Which sums shall be invested at what point in time, pending upon which conditions. Just as interesting the question on how a potential earn out shall be structured. In both cases one might learn that agreeing on a valuation is more of a relative rather than an absolute success.
Finally, getting to the core of the matter, the term “valuation” of a company refers mostly to the „gross valuation“, thus the so called enterprise value. Which needs to be distinguished from the equity value the shareholders benefit from. To get an idea, company cash is added, debts substracted and working capital taken into consideration. But how, to pick one of the related topics, shall a particularly high proportion of finished goods or receivables be accounted for?
Lastly, and this too can only be hinted upon in the course of this short article, the final phase of a transaction is likely to presenr its own suprises. Just when the notion that the worst (including a potential due diligence) may be over the wording of seller guarantees or „good and bad leaver“ clauses is again entirely suitable to pour water into the wine of the valuation agreed upon.
It is thus completely understood why valuation issues take such a prominent place in any M&A project, on the one hand. On the other, this is where negotiations start.
So, the answer to “how much” is not a figure.