Valuing+the+company

==Guidelines for creating spin-off companies from higher education institutions, public and private research institutes, and enterprises ==


 * Module 7**


 * Valuing the company**

By definition business valuations means set of procedures to estimate economic value of one business (company). Estimating the worth of one business is a matter of carefully conducted financial analysis. It depends of lot of parameters and varies by its purpose; It is different to valuate private company (start up company), acquisition target or company of a distress. Business valuation is crucial factor in effective management and in order to do it properly three main approaches in estimating the value of a company (business) are aimed.

 **//Income approach//** – It is based on estimating fair market value of the company by multiplying (future) benefits stream times the discount rate. Discount or capitalization rate presents the present value of expected returns and carries the risk factor associated to the business subjected to the valuation. It is usually higher for start up/spin off companies (new businesses in general) due to the higher risk they are exposed. There are several methods to calculate discount rate. Most popular and widely used method is calculating Weighted Average Cost of Capital (WACC). WACC determines a firm's cost of capital in which each category of capital (debt and equity) is proportionately weighted.

**//Asset approach//** – It simply estimates “book” value of the company's equity (assets less debts). Comparing with income approach which is based on subjective judgment of the valuators about the discount/capitalization rate of particular business it is relatively objective approach. However it works well on valuing tangible assets, but for intangible assets like brand name or IP portfolio is hard to estimate their value using this method. Thus this approach is not a right choice for valuing going business concerns.

**//Market approach//** – It is based on logic that in the free market environment the demand and supply forces will drive the price of some business asset to equilibrium. Consequentially nobody will pay more or sale the business for less, than the value of comparable businesses in its industry. For large enterprises, comparable with publicly traded firms this method looks at multiples of publicly traded stocks. For smaller companies it examines the prices by which the similar businesses have been sold. Professionals who do valuations usually use not just one method, but combination of more in order to get more realistic picture and avoid the possibility of error.

Interested reader can find more on the following McKinsey papers [|mckinsey tutorial for company valuation.pdf] [|Valuation_2005_User_Guide.pdf]


 * Valuation of M&A target**

More complex case is evaluation of **//merges and acquisition (M&A)//** target. For start up companies it may be interesting subject, because if the business is successful, they are usually considered as M&A target of larger companies in same industry. Than the the evaluator has to consider the following factors: Target company Market performance in which targeted company operates Strategic fit with acquirer Deal economics **//Target company is analyzed through//**: Size; Profitability; Development trends; Product portfolio; Customers **//Market performance//** looks at size and growth of the particular market and competitors. **//Strategic fit//** with acquirer examines if the targeted company makes sense to acquirer with: Capacity; Distribution; Production Line; Technology; Brand; Customers. Furthermore it considers the possible cost savings due to the economy of scale. **//Deal economics//** estimates how the target is worth for the acquirer. It consists of stand alone value (classical company valuation), plus synergy value. The other point is how the acquirer will finance the deal.

<span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left; text-decoration: none;">** Valuation of the company of distress ** <span style="color: #000000; display: block; font-family: Arial,Helvetica,sans-serif; text-align: left; text-decoration: none;">Classical models of business valuation are based under assumption of ongoing concern. However every firm can face the danger of bankruptcy. Valuation of the firm of a distress is different and more sensitive than the valuation of healthy business. The likelihood of distress should be incorporated in the discounted cash flows (DCF). As a first step one has to define under which circumstances the firm is going to fail. Then the likelihood of distress is estimated using probability distribution. The common way of doing this is by running simulations. Onces the probability of distress is calculated, the expected cash flows can be expressed as: <span style="color: #000000; display: block; font-family: Arial,Helvetica,sans-serif; text-align: left; text-decoration: none;">Accordingly the value of failing firm is much lower than the value of the healthy firm. <span style="color: #000000; display: block; font-family: Arial,Helvetica,sans-serif; text-align: left; text-decoration: none;">The other approach of of valuating the distressed firms is relative approach. It looks how comparable businesses facing the bankruptcy are valuated.
 * //<span style="color: #000000; display: block; font-family: Arial,Helvetica,sans-serif; text-align: left; text-decoration: none;">Expected Cash Flows(under distress) = Ongoing Cash Flows * (1- Probability of distress) //**

<span style="color: #000000; display: block; font-family: Arial,Helvetica,sans-serif; text-align: left; text-decoration: none;">More information in the following reading <span style="color: #000000; display: block; font-family: Times New Roman,serif; text-align: left; text-decoration: none;">