Business

What is M&A Valuation and its Key Methods?

Mergers and Acquisitions (M&As) play a critical in the business world. Many consider them to be mechanisms that increase the market economy’s effectiveness and efficiency. However, typical M&As are time-consuming, complicated, and involve multiple parties’ motivations and interests. Therefore, accurate numbers are the key to success in an M&A transaction, resulting in profits for all the parties involved. That is when professional M&A valuation support services help to do the necessary calculations. 

Here, we will look at the various M&A valuation methods so that one can choose the right option for their transaction.

General Approaches

Before delving into the specific methods, here are the general approaches:

Cost Approach

Looking at the balance sheet is a logical way of estimating its value. However, some items may require adjustment to align with the market value. Additionally, some things may not appear on the balance sheet and need inclusion. 

Market Approach

Another approach is to look at the company’s actual sales within a timeframe and compare it with its competitors. While most private companies do not publish their M&A transactions, M&A valuation support specialists know how to procure their proprietary private database.

Discounted Cash Flow (DCF) Approach

The DCF approach estimates value based on a company’s expected cash flows in the future. Projecting the cash flow forms the basis of an organization’s valuation.

Essential M&A Valuation Methods

While understanding these three basic valuation approaches, let’s find the specific methods used within M&As.

EBITDA:

EBITDA stands for Earnings Before Interest, Tax, Depreciation and Amortization. This valuation method evaluates a company’s finances in relation to similar companies. However, it does not include the effects of capital expenditure, corporate taxation, and working capital. This valuation method works well for companies that want to measure their cash flow.

Net Assets:

The net assets valuation method involves subtracting the company’s total liabilities from the sum of all the company’s assets. It is suitable for companies with an asset-rich, stable organization, like manufacturing companies. Remember, this method does not involve the future potential for earnings in its calculations. So, this method works for companies that have abundant assets to show.

Revenue Multiple:

It is the most common method used to determine a company’s value. M&A valuation support experts use his metric to compare companies having different profits but similar products, margins, competition, and markets. This method is the best for companies that are not generating profits at present but have a high growth potential in the coming years.

P/E Ratio:

One may calculate a company’s P/E ratio (price/earnings ratio) by dividing its value by taxes after the profits. An expert multiplies the company’s profit after paying the taxes by a suitable multiple. To calculate a company’s value in equity, it’s essential to add any surplus cash and subtract the existing debt. This valuation method is appropriate for comparing companies within an industry.

Comparable Analysis:

The methodology evaluates two similar companies by calculating their valuation multiples. A larger company may use this valuation method to determine a smaller company’s relative value before acquiring it. It is an effective method to gain valuation data in industries having multiple players.

Precedent Analysis:

The method incorporates revenue multipliers and EBITA to compare a company’s transactions as opposed to similar companies in the industry. It is appropriate when the evaluator wants to assess a company’s market pressure rather than its value. 

“Football Field” Chart:

Through the valuation chart, a valuator can quickly assess a business‘s valuation across varied methodologies, including DCF, comparable analysis, and precedent analysis. The results give a broader perspective than a single valuation method, allowing the evaluator to view different things simultaneously. For instance, when a company provides both products and services to a community, a single valuation method will not be appropriate to measure its two-sided approach. In that case, a football field chart will provide a better analysis.

Dividend Growth:

It assesses if a company’s value has support from the future dividends’ current value. When a company considers selling off its particular sector, it may use the dividend growth method to calculate its value. This valuation method is best suited for a company that wants to assess its minority stakes rather than its entirety.

While preparing for an M&A, these valuation methods can help in several ways. The M&A valuation support teams can analyze and interpret a company’s financial data to ensure accurate reports. With proper accessibility and interpretation, these methods help a company get what it deserves out of the transaction.

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