One of the key aspects of any acquisition is the assessment of the total worth of the target enterprise and in order to arrive at the most accurate figure, various methods have been devised for the valuation for the acquisition of a company. It is an essential activity for any investor to conduct in order to fully comprehend the potential of the acquisition in generating attractive returns.
The choice of the best way to conduct the process depends on a number of factors such as the current and projected financial health of the target company and its age apart from its gross margin, market size and customer acquisition costs.
A list of some of the most productive methodologies employed by M&A advisory firms in India when assessing the value of an enterprise is presented here for the benefit of investors.
Table of Contents
1. Liquidation Value
The amount of capital generated if each and every asset, as well as liability possessed by a company, is sold is called the liquidation value of the entity. All physical assets such as real estate, machinery and inventory are considered for such valuation while any intangible asset does not qualify for calculating the liquidation value.
The final figure arrived at by using the liquidation value method depends on some important factors such as the time available for the sale of assets and the current condition of the organization in question. For instance, a poorly performing firm will look for an early sale which will result in the lower valuation.
2. Enterprise Value
This method allows for a comprehensive assessment of an entity’s value with the formula for its computation involving the addition of the market value of the common stock and the preferred shares to the market value of the debt and minority before subtracting it with cash held and other equivalent investments, to arrive at the final figure.
A lot of experts consider enterprise value technique to be a purely theoretical but accurate method as the effect of the announcement of the acquisition on the stock price is not taken into consideration but other important characteristics such as debt and cash reserves are factored in.
3. Discounted Cash Flow
The appropriate value of companies which are established in their domain and have bright future prospects can be calculated using this technique. The discounted cash flow method involves deducting the company’s average cost of capital from its expected cash flow over a specified period of time to arrive at the final figure.
It can be safely said that any assessment carried out using this procedure will give an investor the estimated returns he/she stands to earn if the acquisition is carried out successfully.
4. Multiples Analysis
One of the most common techniques for valuation for acquisition, the multiples analysis method takes into consideration the financial information of public companies, possessing similarities in products, target markets, margins and competitions, and then convert it into various multiples based on the organization’s performance.
These multiples can be used for calculating the approximate value of the enterprise. This revenue-based technique of evaluation is popular with companies with low levels of profit like technology firms which do not show any gains during the initial years of operation.
5. Comparison Analysis
In this procedure, data about all acquisitions that have been successfully completed over the last few financial years is mined for getting information on those transactions that are related to firms in the same industry.
This data is then used to conduct a comparative analysis for the estimation of the value of the target company. Metrics like earned revenue and cash flow are used for comparing two entities and reach a near precise figure for the investor to consider whether the transaction will be fruitful or not.
6. Price Earnings Ratio
The value of an enterprise when divided by the amount of profit left after deducting the tax, gives the price-earnings ratio. The value of any company can be found by using an appropriate multiple with which the after-tax profit must be multiplied to arrive at the figure.
Once any surplus cash amount is added and the debt subtracted, the new figure generated gives the equity value of the organization.
7. Earnings Before Interest, Tax, Depreciation & Amortization (EBITDA)
Another method that uses the comparison of different entities to find the approximate value of an enterprise, EBITDA is used to assess the target company’s operating cash flow and is calculated by adding the amount spent for meeting expenses like taxes, interests, depreciation and amortization to the net income of the company.
The technique does not find favour with many investors precisely for the reason that it does not incorporate essential expenses such as interests and taxes.
8. Replication Value
The replication value can be calculated by an investor by estimating the funds that would have been needed to build a target company from the ground up. This activity has to take into consideration not only the cost of infrastructure necessary for the organization but also the investment needed for marketing the new enterprise like promotional campaigns and also the monetary input required for building a superior product based on competitor and target audience analysis.
9. Relief From Royalty
In this age of technology, where firms have built huge fortunes by selling intangible products, it becomes necessary to have an efficient technique that can be used for the valuation of such entities. The relief from royalty method lets an investor tries to found out the amount it would have paid as royalty for obtaining rights over the usage of the intangible intellectual property asset of the company in question.
From any third party. The data related to the sale or transfer of the licenses of similar products is used as a reference for calculation purposes in this evaluation technique.
Selecting the most appropriate methodology for computing the valuation of acquisition according to the nature of the target company, is vital for any investor as only then can be an estimation of the costs involved can be generated apart from finding out whether the venture will be profitable or not.