Private Company Valuation Methods and an Important Rule of Thumb

May 1, 2020

The situation in our world right now is changing quickly. Consumers, communities, and businesses of all sizes are experiencing significant economic and social impacts. Businesses are scrambling to address the crisis by making adjustments to their workforce, operations, supply chain, and strategy in an attempt to maintain continuity.

Right now, many private companies have had to make some tough decisions and are looking to sell or merge their businesses, quickly.

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Although the circumstances are not ideal, this is a good time for those with the capital to invest in private companies but they need to move quickly.

If you are looking to invest in private entities, you need to know the company’s economic value to determine if it is worth the time and effort.

Simply put, a company or business valuation is a set of processes used to determine a company’s net worth. This is easily done with public organizations because all you really need to do is look at the stock price.

Determining the valuation of a private company isn’t quite as straightforward because their stock value is not available to the public. Their accounting and reporting standards are also not as strict as their public counterparts so financial statements often are unstandardized or inconsistent.

For the reasons above, we have decided to put together this overview of private company valuation methods.

Method #1: Comparable Company Analysis (CCA)

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The Comparable Company Analysis (CCA) is the most common method used to estimate the value of a private firm and assumes that similar companies with more financial information available in the same industry will operate with similar multiples.

Multiples are measurement tools that evaluate one financial metric as a ratio of another in order to make companies easier to compare. The two main types of multiples are Equity Multiples and Enterprise Value Multiples. Enterprise Value Multiples are the most common multiples used in mergers and acquisitions.

Enterprise Value Multiples are also called EV/EBITDA ratios or EBITDA multiples. They compare the value of a company (including debt and other liabilities) to the actual cash earnings.

To apply this method, the target firm’s size, industry, supply chain, operations, etc. are taken into account.

You then need to establish a group of companies that have equivalent characteristics. The multiples of these companies are then collected to calculate an average.

This – and all of the methods on the list – do take some research and if you are new to private equity investments, it can get fairly involved. Analysis may uncover that a company is overvalued or undervalued when using this method.

Method #2: Discounted Cash Flow (DCF)

The Discounted Cash Flow (DCF) method estimates the value of a business based on future cash flows. DCF analysis finds the present value of future cash flow using a discount rate i.e. interest rate.

Investors use this concept to determine whether the projected outcome is equal to or greater than the value of the initial investment.

If the value calculated is higher than the current cost of the investment, this signals a good opportunity that should be considered because it will yield positive returns.

Applying the Method

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First, applicable revenue growth rate must be calculated for the target firm. This is calculated by determining the average growth rates of the comparable firms that are publicly traded.

Those averages are then used to generate projections for the target firm’s future cash flow (CF) by evaluating assumed revenue, operating expenses, taxes, etc.

The investor must also determine an appropriate discount rate (r), which will vary depending on the industry. Many analysts use the weighted average cost of capital (WACC) as the discount rate.

To find WACC for a comparable public firm, cost of equity, cost of debt, tax rate, and capital structure will all need to be determined. Cost of equity can be calculated by using the Capital Asset Pricing Model (CAPM). Cost of debt generally depends on the target firm’s credit profile, which will affect the interest rate at which it incurs debt. Refer to the company’s comparable public peers to find the industry norm of tax rate and capital structure.

After you have all of this information you can then determine the DCF of your target firm using the formula below:

DCF = CF1/(1+r)1 + CF2/(1+r)2 + CFn/(1+r)n

  • CF is the cash flow for the given year. CF1 is for year one, CF2 is for year two, CFn = additional years
  • r is the discount rate

If this seems complicated, that is because it is. If you don’t have significant experience in financial modeling, we suggest speaking with a professional.

It is important to note that this method is less common and that is because it is mainly based on assumptions and future cash flows would rely on a variety of factors that are difficult to predict and control like the state of the economy and market demand.

The Most Important Rule of Thumb in Private Equity Investing

Some try to say that there is a “secret formula” to determining if a private company is a good investment, but at the end of the day, you need to go with your gut. The numbers could look great but if you don’t think that the investment is right for you or your portfolio, we suggest looking into other opportunities.

At The DVS Group, we are well-versed in valuation analysis. We have helped many investors structure and negotiate their deals in a fair and reasonable way with our buyside representation services.

Learn More About Our Process

Risk Reward Ratio and Determining the Value of a Business

April 27, 2020

Understanding the risk-reward ratio is vital for anyone planning to acquire ownership of a business via private equity investment. When acquiring a business as an investment, there are some considerations that need to be assessed before deciding to proceed with the acquisition to ensure your money is protected and that the company you acquire is profitable.

What is a Risk-Reward Ratio?

Risk-reward ratios are used as a measurement of a business’s financial health and indicate whether or not it is a worthwhile investment and will be profitable in the long term.

Although risk-reward ratios are essential for risk management, merely understanding how the risk-reward ratio is calculated is not enough to make a smart investment. An understanding of the industry the company operates in is also needed, and its impact on the risk-reward ratio.

To make a sound decision, investors need to be fully aware of the level of the potential risk they are taking on when they are making a business acquisition. A thorough understanding of the company’s debt level and how that impacts on its potential profit and prospects for further reinvestment in the business needs to be understood.

How Risk-Reward Ratio is Calculated

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There are a few different risk-reward ratio methods used when assessing how good a private equity investment is likely to be. Different investors may have a preference over which method of calculation that they use. However, these are the most widely used methods for calculating an investment’s risk-reward ratio: debt to equity ratio, debt to capital ratio, interest coverage ratio, and the degree of combined leverage.

Risk-Reward Calculation Methods

Debt to equity ratio – Calculated through how much a company is financed through debt versus funds received by the business.

Debt to capital ratio – Calculated by taking a company’s debt and dividing it by the total capital.

Interest coverage ratio – Calculated by the number of times that a company can cover it’s annual interest payments for debt through its current earnings.

The degree of combined leverage – Calculates the financial and business risks of a company’s earnings per share as a result of increased or decreased sales.

Businesses with a lower debt to capital ratio and lower debt to equity ratio are the preferred choice for investors. Companies with higher debt to capital ratios and higher debt to equity ratios are seen as a less attractive investment opportunity as they offer little security or reassurance of a company’s long term profitability.

Risk-reward for private equity investments applies similar rules as those used in trading stocks and shares. Investors use the ratio to manage how much capital they are investing and manage the risk of loss. Using the ratio also helps investors to calculate how much return they can expect from the money they invest and will help to show how risky the investment is.

Determining the Value of a Business

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No one wants to spend more than they need to acquire a business. Therefore, calculating the value of a company is essential. It is crucial to remember that the value of a business will change over time, so finding a data-based, objective way to establish its value is ideal, rather than relying on the price that the seller wants to charge.

The value of a business is influenced by both internal and external factors, which means that the value can fluctuate by conditions both in the business’s control and those that it has no control over.

Internal factors such as investment in the future of the business and management changes can influence the value. External factors such as the economy or changes to the legislation can also impact value.

There are three main approaches used to calculate the value of a business: the asset approach, the income approach, and the market approach.

Asset approach – the asset approach calculates a company’s value based on its assets and liabilities. However, this approach overlooks assets that aren’t tangible and therefore, almost impossible to value things like patents, intellectual property, and reputation.

Income approach – the income approach to business valuation is based on a company’s cash flow minus the legitimate expenses that it incurs. Looking at a few years of the company’s cash flow information and taking an average will help you to estimate the business’s future earnings.

Market approachthe market approach is based on comparison and determines a business’s value based on data from companies operating in the same or related industries. This offers a reliable method of valuing a business as it is based on real-world examples of what a business is realistically worth.

Using the Market Approach to Evaluate Industry-Specific Investment Risks

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To gain a thorough understanding of a business’s potential profit versus its potential risk, it is essential to understand the industry in which it operates. This can be achieved by examining comparable companies operating in the same industry for guidance and utilizes the market approach to business valuation.

Investors that are considering the acquisition of a private company can refer to publicly traded companies in the same industry or that provide similar offerings and use this to evaluate the risk of their potential investment.

To ensure that the prospective investment will provide a worthwhile return, a risk-reward ratio can be seen in these similar businesses over the timeframe that you plan to hold onto the company before selling it to realize their return.

This information is extremely valuable in the decision-making process for business investments, as it takes objective data from the real world as the basis of the decision-making process.

Whether you’re an individual looking to acquire a business, the experts at DVS group can help you every step of the way. If you are ready to get started, call us at (913) 701-3475 or use the contact form to set up a consultation. You can also click below to view our Acquisition Workbooks and resources.

Check Out Our Acquisition Workbooks!

Your Guide to M&A Deal Closing and Processes

April 20, 2020

As global competition continues to intensify, growth is at the forefront of many minds in the investment world to increase value and maintain revenue. To be fair, growth has obviously always been at the forefront but digital technology has kicked things into high gear in the last 20 or so years.

 

Many are currently looking to pursue this growth and stay competitive by carrying out mergers and acquisitions (M&A) which can be a challenging feat. However, if you know the processes and work with an investment firm that understands your goals, it can bring in big money.

 

Table of Contents

  • The Stages of an M&A Transaction
  • Coordinating State Filings Before Closing
  • Simultaneous Signing and Closing vs. Deferred Closing
  • Closing Time
  • Post-closing Important Things to Know

Whether you are new to the M&A world or just wanted a refresher on how closing processes work, we are here to arm you with the information you need to prepare for your next big deal.

The Stages of an M&A Transaction

Before we get into the closing process, let’s do a brief overview of the entire transaction. This starts after you have consulted with a firm and have chosen a company to buy that you believe will help you and/or your enterprise reach your financial goals.

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While every M&A transaction is unique, most of them fall into a similar pattern.

  1. Preliminary discussions: Here buyers and sellers engage in informal talks to see whether a transaction is worthwhile. Companies may decide to include representatives consultants but rarely discuss deal structures.
  2. Provision of non-disclosure agreements (NDAs): Here all parties concerned sign a legal agreement to remain tight-lipped about information relating to any upcoming M&A deal.
  3. Letter of intent: If the buyer likes the terms of the deal that have been laid out and wants to move forward with the transaction, they’ll issue a “letter of intent.” This idea here is to write down the structure of the deal formally and set out the terms under which acquisition or merger might be worthwhile.
  4. The pre-signing period
    1. Negotiating the final document: Both sides engage in a final negotiation period with legal counsel, to hash out the terms of the final deal. They may decide to set out the terms in the letter of intent formally, or they may modify or add to those terms in some way.
    2. Completion of due diligence. Buying parties usually want access to more in-depth information about a company at this stage and will circulate a list of information requests to their target. This list might include financial documents, intellectual property documents, and essential commercial contracts.
    3. Population of disclosure schemes: Population of disclosure schemes are a form of insurance for the buyer that provides them with recourse, should the target company fail to disclose certain information, or breach the terms of the contract. This document includes representations and warranties that describe the operation of the firm.
  5. Signing: Signing occurs when both parties agree on the terms set out in the formal purchase agreements. Signing can happen at the same time as closing, but not always – we will discuss this in the next section.
  6. Closing: Closing occurs when both parties are satisfied with the terms of the deal, and money changes hands from the buyer to the target.

Coordinating State Filings Before Closing

For an M&A to be official, you need to file with the relevant state authorities. In the US, not all state requirements are the same, but there are some general guidelines you should follow prior to closing.

Pre-clear Certificates Of Merger

You don’t want to get to the closing date and discover that the state will not accept your Certificates of Merger. For this reason, it is better to “pre-clear” documentation with relevant authorities before completing the transaction.

Use an Updated Charter

Some buyers get into trouble when the charter of the target firm changes, but there are no amendments to the Certificate of Merger. To check whether things have evolved, you should obtain a Good Standing Certificate – a document that will inform you of any alterations to the original text. When possible, date the Good Standing Certificates as close as possible to the date of closing.

Simultaneous Signing and Closing vs. Deferred Closing

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The type of closing process that is carried out can greatly affect the length of the transaction and how much leg work you and your team need to put in to finally close the deal. Here we will take a look at simultaneous signing and closing and deferred closing.

Simultaneous signing and closing

Both parties agree to sign and close the M&A deal at the same time.

Simultaneous signing and closing normally occurs in smaller deals that do not require a premerger notification form (see below), do not need a third-party present, or government approval for completion.

Think of simultaneous signing and closing as using a box of cake mix to bake a cake. It is much faster and easier to complete because you do not need as many ingredients or a full-blown recipe to get a finished product.

Deferred closing

There is a period of time between the signing of the documents and the final closing and exchange of money.

Deferred closing is like the cake you make from scratch. You still get a cake – or a closed deal – but it takes extra ingredients and time to get to the finished product.

There are two common reasons why many M&A transactions are deferred, but it is important to note that there are many other reasons that deals do not simultaneously sign and close.

First, if the transaction value for an M&A deal equals or exceeds a certain amount, a premerger notification filing with the Premerger Notification Office of the Federal Trade Commission (FTC) may be required by law, and the parties must wait 30 days to complete the deal.

This waiting period is subject to exceptions and can be terminated early by the antitrust authorities if there are no competition concerns.

If competition concerns are present, the waiting period may be extended, and the parties can receive a request for additional information and materials. This could easily add several months to a transaction timeline.

The other common reason is that the sale may require a third party or governmental approval, especially in highly regulated industries. The period of time this can extend transactions can vary greatly depending on the situation.

Deliveries on deferred closing – and some simultaneous signing and closing – deals might include things like:

  • Evidence of third-party consents
  • Acquiring legal opinions
  • Ensuring that key employees sign necessary agreements
  • Obtaining government approvals
  • Gaining ancillary contracts with third parties
  • Consent of the board and stockholders
  • A secretary’s certificate affirming that the charter documents of the target company are accurate

Closing Time

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Once all closing conditions are agreed upon, parties will proceed and complete the transaction.

Although we all like the idea of going into a huge board room and signing the contract with a fountain pen that weighs almost as much as a coffee mug, the transaction is usually completed electronically.

If necessary, the buyer will pay cash by wire transfer to the seller’s bank account and/or issue shares of the company.

At this time, a portion of the purchase price might be sent by the buyer to a third party financial institution serving as an escrow agent.

Various closing certificates will also be exchanged and things like transition services or ancillary agreement or employment agreements, might also be signed and become effective.

After this is all complete, the buyer now owns the acquired assets, and the seller has received all of the money from the transaction (unless some is tied up in escrow).

Post-closing: Important Things to Know

You may think that since the transaction is closed that means that the buyer and seller relationship is over, but that is far from the case in most situations.

Initially, the parties will likely cooperate in determining if it is necessary to pay a difference in the purchase price to reflect the actual assets or working capital that was previously agreed upon.

A seller may also provide transition services to help the new owner successfully move into their new position. This could involve anything from a briefing of operations to IT support.

There are many other potential post-closing conditions that may tie the buyer and seller that may remain effective for several years post-closing.


Whether you’re an individual looking to make a change, an executive hoping to make a strategic move, or a professional investor, we bring unique knowledge and skill to every step of the M&A process and provide you with the resources you need to succeed. Click below to check out our acquisition workbooks. If you are ready to get started on your next deal, call us at (913) 701-3475 or use the contact form to set up a consultation.

Check Out The DVS Group Acquisition Workbooks

Business Growth During Coronavirus: A Successful Merger During Chaos

April 13, 2020

Can anyone use a feel-good business story right now?

15 years ago, DVS Managing Partner Kevin Lindsey mercilessly cajoled and harangued a friend, Janine Akers, for about a year into buying a business. “She was so smart, so confident and so driven, it was just so obvious she needed to own and control a business,” he said.

At that time, Janine was also the mother of two daughters under the age of four,  was running a home-based business, and her husband, Bill Akers, had recently bought into Ace Scale Company which was based in a different city. Hard to imagine a better time to make the jump and buy a business and create a dual entrepreneur household, huh?

Building a Business and Completing a Merger During Coronavirus

Eventually, Janine bought DataFile Technologies, a medical record scanning business, that consisted of two scanners, two employees and a handful of customers. There are so many incredible stories about this dual entrepreneur household making it work.

It has been amazing to watch this brilliant, fearless woman grow a small company into an industry leader with over 325 employees. Janine recently completed a successful merger with another industry leader, ScanSTAT Technologies, in the middle of a harrowing business crisis.

“When I first started DVS Group, I was driven by the idea of helping good people buy good businesses and they will do good in the world, which eventually became our why – Make Change Positive,” said Lindsey. “Janine embodies everything our Why and what that stands for.”

Janine was the first deal that was closed while social distancing was in place – which is a bit of a bummer, but we are confident that we will be able to have a real closing celebration soon enough.

Watch our world, as Janine Akers is only getting started!

We can’t wait for the second, third and fourth acts. #nofreelunchcards. You go, girl!

A special thank you to Erik Edwards, Bill Mahood, Steve Munch, Polsinelli, Michelle Brown, Kathryn Rhodes, CBIZ, Frankie Forbes, Forbes Law Group, Vistage.

See More Done Deals From Our Team

“Can I Afford to Buy a Business?” Two Frameworks to Help You Answer That Question

September 27, 2017

If you’ve ever considered purchasing a business, the thought right after, “I can be my own boss!” is likely “Can I even afford it?” Business ownership is rewarding in many ways- beyond finances. But it also brings lifestyle changes that impact those around you. It’s an investment you want to be confident in.

We won’t talk in absolutes about whether or not you can afford to buy a business. But, after a decade of seeing executives buy businesses, we’ve developed two frameworks that work in tandem for helping you answer that question.

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70-90% of Strategic Acquisitions Fail – Here’s How Corporate Buyers Kill Deals

September 6, 2017

Strategic acquisitions have a historical failure rate of 70-90%. That’s a pretty dismal stat.

So, what are you doing wrong? And, more importantly, how do you properly lead your team in an acquisition process when the cards are stacked against you?

Below are five of the most common mistakes we see corporate buyers make when going through the acquisition process. These mistakes can be costly – especially, if the deal dies after you chased it for months. We’ve included reminders of basic, yet vitally important, acquisition principles that will allow you to steer clear of failure and action items to help your team gain momentum in the right direction.

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Buckle Up! 4 Ways Your Journey to Buy a Business Could Get Derailed

April 12, 2017

Are you properly settled in for the ride as a Blue-Chip Executive on the journey to buy a business?

The journey can be long and arduous, and you might get lost and never arrive, or crash on the way, or get distracted, or wind up at the wrong destination.

So, as you’re buckling your seatbelt, examine the ways your journey to buy a business could get derailed and then, take our tips to heart – they will help you stay on track.

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How to Choose the Right Investment Banker

February 23, 2017

You have a deal you want to get done. You’re ready to buy a business. Or, maybe ready to sell. Or, looking for a business partner. Or, wanting to refinance. But you need help. Well, investment bankers are all about helping you with that deal.

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Financial vs. Strategic Buyer

January 23, 2017

The distinction between a financial buyer and a strategic buyer is pretty straightforward.

A financial buyer acquires a company as an investment for returns. A strategic buyer acquires a company to advance a business plan.

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Selling Your Business? The Key Is Preparation

December 15, 2016
You have worn many hats throughout your life- child, sibling, spouse, parent, business owner. To many, the role of business owner may appear to simply be a job title. But to those of us who know better, the role of business owner becomes an integral piece of a person’s life. The time, effort and money put into the business instills a deep care for the business, its people and its future.

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