Business Valuations in Merger & Acquisition Transactions

Contact Neufeld Legal PC for corporate transactional and legal matters at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

Putting together the complex pieces of mergers and acquisitions.

Valuing the worth of a particular business is a challenging endeavour, based on perception and expectations, as opposed to pure science. This makes the process extremely difficult and highly opinionated. And to make matters worse, the identification of additional information and potential problems, during the course of the due diligence process, can further alter the valuation of a particular business.

As such, a valuation may be set forth by a certified business valuator, than be subjected to alterations based on further investigations, than subjected to the other side professional and/or opinionated valuation of the business, leaving a range of numbers and rationales from which the purchase/sale price must ultimately be determined. As is evident, this can be very a challenging process that is heavily influence by opinion and belief, that the final results tend to be highly uncertain. Nevertheless, the value of a professional valuation cannot be understated as it can represent the base point from which effective negotiations can be conducted, as there is an arguable basis for one's position, although it remains an argument that need not be accepted.

Professional valuators typically utilize a mixture of three main approaches to determine a private corporation's value:

• Income-Based Approach: This approach values a business based on its ability to generate future earnings or cash flow. The core principle is that a company's value is the present value of its expected future income. The most common methods include:

  • Discounted Cash Flow (DCF): This is often considered the "gold standard" of valuation. It involves forecasting a company's future cash flows and discounting them back to their present value using a rate that reflects the risk of the business. DCF is great for high-growth companies or those with fluctuating cash flows.

  • Capitalized Earnings: This method is used for businesses with stable and predictable cash flows. It involves dividing the company's average historical earnings by a capitalization rate, which is essentially the required rate of return.

• Market-Based Approach: This approach compares the target company to similar businesses that have recently been sold or are publicly traded. It's based on the principle of substitution, meaning a rational buyer won't pay more for a business than they would for a comparable alternative. Common methods include:

  • Comparable Company Analysis (CCA): This method identifies similar publicly traded companies and uses their valuation multiples (like Enterprise Value/ EBITDA or Price-to-Earnings) to estimate the target company's value. Adjustments are made to account for the private company's smaller size and lack of marketability.

  • Precedent Transaction Analysis: This involves looking at multiples from recent mergers and acquisitions of similar businesses. This is often the most relevant method for an acquisition as it reflects real-world transaction prices, including any control premiums paid.

• Asset-Based Approach: This approach values a company based on the fair market value of its tangible and intangible assets, minus its liabilities. This is often used for asset-heavy businesses like manufacturing or real estate companies, or in liquidation scenarios.

  • Adjusted Book Value: This method starts with the company's book value (assets minus liabilities on the balance sheet) and adjusts it to reflect the current market value of those assets and liabilities.

  • Liquidation Value: This method estimates the net cash that would be received if all the company's assets were sold off and liabilities were settled. It's a "floor" valuation, representing the minimum a company is worth in a worst-case scenario.

Valuing a privately-held corporation is challenging because it involves more subjective judgments and assumptions than valuing a public-held company, including:

• Limited Financial Data: Private companies aren't required to disclose their financials to the public. The available data may be less reliable, incomplete, or not audited. Furthermore, the financial statements often include discretionary or non-recurring expenses that need to be "normalized" to get a true picture of the company's performance.

• Lack of Liquidity: Unlike public company shares, which can be easily traded on an exchange, private company shares are illiquid and difficult to sell. This lack of marketability often results in a discount being applied to the valuation.

• Subjectivity: The valuation process involves a lot of professional judgment, especially when it comes to forecasting future growth, determining the appropriate discount rate, and identifying truly comparable companies. Different valuators using the same data can arrive at different valuations.

• Intangible Assets: The true value of a private company often lies in its intangible assets, such as brand reputation, customer relationships, proprietary technology, or a strong management team. These are notoriously difficult to quantify but are crucial to the company's overall worth and future potential.

When it comes to the legal component of corporate mergers & acquisitions, that is when the law firm of Neufeld Legal P.C. comes into play. Such that when your company is seeking knowledgeable and experienced legal representation in orchestrating and completing business mergers, acquisitions and divestitures, contact us at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or Chris@NeufeldLegal.com.