In short, our book is a roadmap for creating value in both running a business and selling or buying one. Many investors have heard of building value in a public company, where the stock price provides the market's reaction to the company's performance.
Winning through Merger and Acquisition
Taking these characteristics into account, fair market value is defined by Internal Revenue Service Revenue Ruling 59-60 as. So any premium the buyer pays above fair market value reduces the buyer's potential profit because the seller receives that portion of the value created.
Building Value in a Nonpublicly
Traded Entity
Estimate the company's true economic return, measured as its net cash flow on invested capital (NCFIC). To create value through increasing the company's net cash flow on invested capital, consider the following example.
Competitive Analysis
Cumulatively, the identification of risk and value drivers establishes the company's strategic advantages and disadvantages. These factors must also be assessed in light of the company's internal capabilities and external environment.
Merger and Acquisition Market and Planning
Process
Identify Potential Consequences of Inaction
Their financial and professional future can be greatly affected by a sales decision, so these matters need to be discussed. Partners and employees may also be affected favorably or unfavorably by the decision, and it may be necessary to consider these personal and financial implications. Business leaders are often so immersed in the day-to-day challenges of running the business that they lose sight of the larger value maximization goals outlined in Chapters 1 and 2.
Without routine attention to what drives long-term value, especially standalone versus strategic value, big sales opportunities can be missed. Advanced planning, often over a number of years, may be necessary to exploit the company's strengths and minimize its weaknesses.
Identify Key Nonfinancial Issues
Assemble an Advisory Team
This can result in the seller not getting the best advice on value maximization strategy, preparing the business for sale or even on how to get the highest possible price. Conversely, the valuation consultant may have little M&A experience or industry contacts, which are essential when selling certain types of businesses. Company managers may, due to their involvement in the company's operations, lose perspective in assessing important competitive factors.
Less experienced appraisers also often have difficulty distinguishing between stand-alone market value and investment value in the valuation and analysis process. As discussed further in Chapter 14, the seller must relentlessly focus on the after-tax cash proceeds received from the sale.
Identify Likely Alternatives
Preparation and Financial Assessment of Alternatives With the likely alternatives identified, the advisory team should
Address the need to prepare the company for a sale. The valuation of the business will have identified the factors that most influence the value of the business and based on this the timing of the sale can be considered. Economic and industry conditions may not be ideal at this time, or the company can benefit greatly by pursuing short-term strategies that better position the company to achieve maximum sales value. The preparation can take several months to a year, but should allow the owners to present the company in the most advantageous way.
Prepare the company for sale. Many of the details in the preparation and sales process are managed by. Strengthen the credibility of the financial statements, especially if the company is quite profitable with a healthy balance sheet.
Preparation of Offering Memorandum
A significant objective of the offer memorandum is a clear expression of the company's strategic advantages as a candidate for acquisition, as well as what processes, capabilities and proprietary systems can be transferred to the buyer. The company's strategic strengths should be highlighted, especially how these can be exploited by a buyer. This section of the sales brochure usually begins with a description of the company's history and extends to a forecast of its anticipated operations.
The acquisition strategy must fit the company's overall strategic objective: increase net cash flow and reduce risk. This is a clear warning to return to the company's basic strategy and goals and examine whether this acquisition fits.
Tie Acquisition Plan to Overall Strategic Plan
When the acquisition plan begins to diverge from the strategic plan, when its relationship to the strategic plan tends to blur or become less well defined, stop.
Form Effective Acquisition Team
Specify Acquisition Criteria
Consider Target Weaknesses versus Acquirer’s Strengths As acquisition criteria are evaluated, managers should be encour-
Define Search Process
Select Search Criteria and Find Target Companies
Revenues. Returns are usually assessed based on size, and usually the target will be smaller than the acquirer. The decision on where to expand next should be based on the acquirer's overall strategic plan. Whether the target's management should be retained. Usually this choice is influenced by the degree of competent management of the acquirer.
Private companies or public companies. In general, this choice depends more on whether the acquisition is in line with the buyer's strategic plan. This process works best when the desired targets are in the same industry as the buyer because it
Establish Guidelines on Initial Contact Procedure
The outsourced professional's contact may circumvent potential targets' attempts to qualify the acquirer before the acquirer has determined his or her interest level.
Establish Procedures to Review the Acquisition Team’s Recommendation
Determine Tone of Letter of Intent
Although they receive much less publicity because the buyers and sellers are often privately held, these transactions, as noted, constitute the bulk of deal activity in the United States. Five years of historical financial statements, quarterly _____ Breakdown of sales by top ten customers over the past five years. Breakdown of sales by product line, including price and volume details _____ Breakdown of operating costs by product line.
Summary of significant accounting policies _____ Budget and marketing plan for at least one year _____ Financial projections for at least one year. Sales force productivity statistics and sales plan for each department or product line for the most recent year.
Measuring Synergies
These improvements are often the result of technological or process improvements that can be applied on a broader basis to the combined entity. These financial economies raise the target's investment value, but not its fair market value. The value of the acquisition and its success are critically linked to the achievement of improved cash flows according to the intended timeline.
Represents the goal of the combination, which should be an ongoing guide to the acquisition's operating plan. To achieve success, these should be planned in great detail prior to the acquisition to achieve the timing of synergy improvements.
Valuation Approaches and Fundamentals
Please note that all general intangible characteristics of the business, including employees, customers and technology, will be included in the calculation of the value of invested capital. Invested capital is also called the enterprise value of the company on an operating basis, because the entire company… The goal is to calculate the value of the company before considering how its operations are financed with debt or equity.
The value of the minority interest can be increased by provisions in a shareholders' agreement that limit the majority owner's access to the company's cash flows.). Similarly, dividends are analogous to the payout or decrease in the value of the investment during the holding period.
Income Approach: Using Rates and Returns to
Establish Value
The values determined by the income approach and the market approach include the value of all tangible and intangible assets used in business operations. The return used in the calculation – the numerator – should be a realistic measure of the company's long-term sustainable performance. The terminal value represents the value of all future returns after the individually forecast period.
In both the SPCM and the MPDM, the calculation of value is affected by the magnitude of g, the long-term growth rate of the. A good way to start choosing the long-term growth rate is by considering macroeconomic factors.
Cost of Capital Essentials for Accurate Valuations
Company specific premium - rate adjustment for the specific risk profile of the subject company. Equity risk premium ERPE - the long-term average rate of return on common stock that exceeds the long-term average risk-free rate of return. Simply put, the required rate of return on equity—the cost of equity capital—is equal to the sum of the risk-free rate.
The 9% difference is due to the use of SCP and SCRP factors in the MCAPM calculation. Calculated under the CAPM by multiplying the equity risk premium by beta.
Weighted Average Cost of Capital
It is generally easy for publicly traded companies to determine the appropriate weightings between debt and equity to use in the WACC calculation because the market value of debt and equity is readily available information. Equity value can be determined by multiplying the company's share price times the number of shares, and the resulting market values of the debt and equity determine their weights in the WACC calculation. The 40% debt and 60% equity weighting from Exhibit 9-3 produced $3.6 million in equity value, which is 82% of the resulting.
To determine fair market value, the target's WACC must be calculated to calculate what the business is worth to its current owners as a standalone business. In short, the role of the WACC is to provide a return appropriate to perceived investment risk, and not to reflect the buyer's risk profile or cost of capital.
Market Approach: Using Guideline Companies and
Strategic Transactions
Adjustments may also be necessary if one or more of the guidelines use accounting methods that differ from the target. Also, begin the process of relating the target's operating performance, products and other characteristics more closely to certain of the guideline companies than others. Based on this comparison, judge judiciously whether the target is as strong as the average - the mean or median - of the guideline companies.
It should reflect the competitive conditions that are driving risk and value in the industry and the target's strengths and weaknesses relative to the guide companies and their respective multiples. The objective should be for the multiple of the time period of the guiding company to be approximately the same as that of the target.
Asset Approach
Doing so includes adding assets that are not on the balance sheet and removing any on the balance sheet that do not have market value. This procedure leaves the more recent higher costs - those that most closely approximate the current market value - in inventory on the balance sheet. Such adjustments can be accomplished either by creating a current liability, called deferred income tax, or by offsetting the tax against the increased value of the inventory on the balance sheet.
Other items should be converted to market value based on the benefit they provide to the business. On the balance sheet, goodwill or general intangible value should be removed and replaced with market value.
Adjusting Value through Premiums and Discounts
The applicability of adjustments for control or lack of control can be determined by answering the following question for each valuation method: Whether the degree of control implicit in the valuation method was the same or different from the degree of control inherent in the interest being valued. If levels of control are different, a control premium or a discount for lack of control may be required. For example, the M&A method implies a degree of control roughly equal to the degree inherent in acquiring a 100% stake in a company.
If this data is used to value a comparable ownership interest, no discount or premium is required because the method produces a value that reflects a degree of control appropriate to the interest being valued. If the characteristics of the initially determined value differ from those of the interest being valued, a premium for control or a discount for lack of control may be necessary to determine the correct value.
