Accurately valuing a non-public company whose shares are not traded on a stock exchange is always a non-trivial issue. Each person interested in a transaction can apply their own valuation methods and argue with others, defending the correctness of their own calculations. There is no universal recipe here.
Modern methods of evaluating companies, admittedly, are not far from the classic book truths prescribed by Mason and Harrison. Business angels, private investors, venture capital funds and entrepreneurs still use ratios and multiples, discounted cash flows and net assets. But which method is right for you?
General provisions
Estimating the value of a company involves a number of assumptions, in particular, the real size of the market (young, emerging industries are especially difficult to “digitize”), as well as financial forecast. Often, an entrepreneur's business plans may not coincide with the investor's vision.
Another subjective indicator is the degree of return required by the investor to cover all his risks. The earlier an investor “enters” a company, the higher the return he requires. At the earliest stage of development, only one company out of ten invested turns out to be profitable, notes Konstantin Fokin, president of the National Association of Business Angels. “I work closely with companies because I want the profitability of my portfolio to be your average, I expect that two out of ten portfolio companies can be successful,” says business angel Alexander Borodich about the realities of high-risk investing.
When assessing the market and companies, entrepreneurs rely on similar transactions that have already taken place, which will allow them to obtain an approximate multiplier and understand the size of the market. The investor makes the final decision on the value based not only on data from similar transactions, but also on his own intuition and the results of “bargaining” with the entrepreneur.
At the earliest stage of company development, the investor Special attention pays attention to the analysis of other company indicators: the team, potential demand for technology, systemic risks associated with the general economic and political background, as well as possible barriers to entry for competitors.
At the idea stage, it is very difficult to give even an approximate assessment of the future company - this is an equation with many variables.
But an investor is unlikely to be satisfied with such an answer. “Business angels invest money in businesses; they do not finance research projects,” states Igor Panteleev, executive director of the National Commonwealth of Business Angels. Most often, private investors reject startups precisely because the young company lacks sales.
Discounted Cash Flow Method
Fits: For fast-growing, early-stage startups with little or no revenue.
Not applicable: to tech companies.
Basis of assessment: the value of the company is determined from the amount of free cash flow future periods. The flow amount is discounted taking into account the risks of future years. The discount rate is determined based on the weighted average cost of capital.
Minuses: overestimation of the real value of the company, inaccurate assumptions (company revenue in future periods, sales growth rates, risks, discount rate).
Method of multipliers and coefficients
Fits: For established and profitable companies with modest assets.
Basis of assessment: Comparison with listed companies with similar operating and financial structure. The valuation is based on several indicators: turnover, EBITDA, EBIT, annual growth. Transactions with similar companies that were sold to strategic or financial investors are taken into account. Of great importance in this method is the ratio of the market price of a company's shares and its net profit per share. The assessment determines the development potential of a company or industry as a whole; as a result, the investor or entrepreneur assesses the strategic value of the company.
Minuses: difficulties in finding a suitable analogue, closeness of similar transactions, complex data collection process.
Net asset method
Fits: For large companies with significant underlying assets.
Doesn't fit: for the small and medium enterprises sector.
Basis for assessment: balance sheet indicators of the company. An important plus this method— the ability to qualitatively check the resulting value of a business based on its official accounting documents.
Minuses: Difficult to value intellectual property.
Other methods for valuing companies
Lucius Carey's Rule of Thirds: The company is divided into three parts between the investor, the founder/director and management.
Competency Rule: the assessment of each party’s share is based on the professional skills and competencies of the company participants.
Greed factor: the amount of investment multiplied by the share of the director of the business is divided by the investment of the director himself multiplied by the share of the investor. If the resulting coefficient is from 5 to 8, the company’s valuation is adequate; if it is more than 10, the entrepreneur is greedy and gives investors too small a share.
Real experience
Sergey Toporov, senior investment manager at LETA Capital fund:
We use different valuation methods - from discounted cash flows to the method of comparing projects by metrics and predicting the future value of the company. At our stage of investment, the most applicable, of course, is forecasting future value with discounting at the current moment.
Most effective method appraisals are a method of negotiation. We understand the minimum, comfortable and maximum assessment of the project for us. Next, we communicate with the project and compare this assessment with the expectations of the founders. The figure we settled on is the real cost of the project today.
Margarita Vlasenko, project curator of the IT park in Naberezhnye Chelny:
We use the income method when estimating the cost of IT projects. In Russian realities, it is extremely difficult to use the comparative method. It is difficult to find similar businesses and almost impossible to access real numbers. Negative side cost method is that it does not take into account the cost intellectual property, the “burning eyes” of the team and other intangible values. But at the initial stage, the further success of the project depends on them. In practice, the income method provides the most reliable data on a startup. But here, too, you need to understand that none of the approaches provides an objective assessment if we are talking about a start-up business in IT. It is impossible to make long-term forecasts for startups, since sometimes projects undergo major changes in their business processes in the first year of existence.
Danila Nekrylov, analyst at Bright Capital fund:
Traditional approaches to company valuation (comparative, cost, income) to determine the pre-money valuation of a venture project are practically not used. This is due to a high degree of uncertainty regarding the future cash flows of the project, and often the absence of analogous companies in Russia and in the world. And evaluating a project based on its liquidation value often leads to such a figure that it makes no sense for the founder to continue the project in the future.
In the venture business, project cost estimation is the result of negotiations between the company founder and investors. Often a venture fund evaluates a project based on its previous experience of investing in projects at the same stage of development.
If, suppose, in one venture project for $1 million, an investor received 30%, and for exactly the same amount you can only give him 10%, then the investor will have many questions about why your project is better than its analogue.
The following scheme is also used to determine the project assessment range:
- The venture fund determines a “comfortable” share in the investment project, usually it lies in the range of 15-45% and depends on the stage of the project and the presence of other investors. Funds, as a rule, are not interested in control.
- Accordingly, if the investor for the amount of investment required by the project does not receive his comfortable share in the project, this will serve as the beginning of long negotiations. There are two variables in this model: the size of the investment and the pre-investment assessment of the project by the founders themselves.
Materials used in preparing the article educational program for professional private investors Ready for Equity
What methods (methods) are used to assess the value of a business? How is a business valuation carried out using an example and what goals are pursued? What documents are needed to evaluate the business of an enterprise?
Hello everyone who visited our resource! In touch Denis Kuderin - expert and one of the authors popular magazine"HeatherBeaver."
In today's publication we will talk about what a business valuation is and why it is needed. The material will be of interest to current and future entrepreneurs, directors and managers of commercial companies and all those who are close to business and financial topics.
Those who read the article to the end will receive a guaranteed bonus - a review of the best Russian companies, specializing in business valuation, plus advice on choosing a reliable and competent appraiser.
1. What is a business valuation and when might it be needed?
Any business - be it an enterprise producing plastic cups or an automobile manufacturing complex - strives to develop and expand its sphere of influence. However, it is impossible to correctly assess your prospects without a comprehensive analysis of the current state of affairs.
It is business assessment that gives owners and managers of existing commercial enterprises a real picture of the company's assets and its potential.
In what cases does a business need an assessment:
- sale of the entire enterprise or its shares in the form of shares;
- rental of an existing business;
- development of new investment directions for the purpose of expansion and development of the company;
- revaluation of funds;
- reorganization of the company - merger, separation of individual objects into independent structures;
- liquidation of the company as a result of bankruptcy or termination of operations;
- issue or sale of shares;
- optimization of production and economic activities;
- changing the company format;
- change of leadership;
- transfer of assets as collateral;
- transfer of enterprise shares to the authorized capital of a large holding company;
- company insurance.
As you can see, situations in which a business needs professional assessment, a bunch of. But the main objective There is always only one such procedure - competent analysis financial efficiency enterprises as a means of making a profit.
When initiating business assessment activities, interested parties want to know what kind of income a specific commercial structure is generating or will generate in the future. Sometimes the assessment task is even more specific - to answer the questions: develop or sell the company, liquidate it or try to reorganize it, should we attract new investors?
The value of a business is an indicator of its success and efficiency. The market price of a company consists of its assets and liabilities, the value of personnel, competitive advantages, profitability indicators for the entire period of existence or a specific time period.
Small business owners and individual entrepreneurs The question may arise: is it possible to evaluate a company independently? Alas, the answer is no. Business is a complex and multifaceted category. You can get a rough estimate, but it is unlikely to be objective.
And one more important nuance - independently obtained data does not have official status. They cannot be considered as full-fledged arguments and will not be accepted, for example, in court or as a .
2. What goals are pursued by business valuation - 5 main goals
So, let's look at the main tasks that are solved during the business valuation procedure.
Goal 1. Improving the efficiency of enterprise management
Effective and competent enterprise management is an indispensable condition for success. The financial status of the company is characterized by indicators of stability, profitability and sustainability.
This assessment is needed mainly for internal use. The procedure identifies excess assets that are slowing down production and undervalued industries that can generate profits in the future. It is clear that we need to get rid of the former, and develop the latter.
Example
During the business assessment trading company It turned out that using rented warehouses for storing products is 20-25% cheaper than maintaining and maintaining your own premises on the balance sheet.
The company decides to sell its warehouses and henceforth use only rented space. There are cost savings and optimization of production processes.
Goal 2. Buying and selling shares on the stock market
The company's management decides to sell its shares at stock market. To make an economically feasible decision, you need to evaluate the property and correctly calculate the share that is invested in securities.
Selling shares is the main way to sell a business. The company can be sold entirely or in parts. Obviously, the value of a controlling stake will always be higher than the price of individual shares.
At the same time, valuation is important for both share owners and buyers. It is also desirable that the appraiser not only name the market price of the package, but also analyze the prospects for the development of the business as a whole.
Goal 3. Making an investment decision
Such an assessment is carried out at the request of a specific investor who wishes to invest his funds in operating enterprise. Investment value is the potential ability of an investment to generate income.
The appraiser determines the most objective market value of the project from an investment perspective. Take into account, for example, the prospects for the development of the industry in a particular region, the direction of financial flows into this area, and the general economic situation in the country.
More information is in the article “”.
Goal 4. Enterprise restructuring
The main goal of an owner ordering an assessment during a company restructuring is to select the most optimal approach to the processes of changing the structure of the company.
Restructuring is usually carried out with the aim of improving business efficiency. There are several types of restructuring - merger, accession, separation of independent elements. The assessment helps to carry out these procedures with minimal financial costs.
In case of complete liquidation of an object, an assessment is needed mainly for making decisions on the return of debts and the sale of property at free auction.
During the restructuring process, it is often necessary to carry out a complete review of the company's current assets and liabilities.
Goal 5. Development of an enterprise development plan
Developing a development strategy is impossible without assessing the current status of the company. Knowing the real value of assets, the level of profitability and the current balance, you will rely on objective information when drawing up a business plan.
In the table, the assessment goals and features are presented in visual form:
№ Objectives of the assessment Peculiarities 1 Improving management efficiency Results are for internal use 2 Purchase and sale of shares Valuation is important for both sellers and buyers 3 Making an investment decision The object is assessed from the point of view of investment attractiveness 4 Business restructuring Evaluation allows you to change the structure taking into account maximum efficiency 5 Development of a development plan Assessment allows you to draw up a competent business plan Method 3. Assessment based on industry peers
Here we use data on the purchase or sale of enterprises that are similar in profile and production volume. The method is logical and understandable, but you need to take into account the specifics of the company being evaluated and specific economic realities.
The main advantage of this method is that the appraiser focuses on factual data, not abstractions, and takes into account the objective situation on the sales market.
There are also disadvantages - the comparative approach does not always affect the prospects for business development and uses average indicators of industry peers.
Method 4. Valuation based on cash flow forecast
The assessment is carried out taking into account the long-term prospects of the company. Specialists need to find out what kind of profit a particular business will bring in the future, whether investments in the enterprise are profitable, when the investments will pay off, in what directions the funds will move.
4. How to estimate the value of an enterprise’s business - step-by-step instructions for beginners
So, we have already found out that only professionals can correctly evaluate a business. Now let's look at the specific steps business owners need to take.
Step 1. Choosing an appraisal company
Selecting an appraiser is a responsible and important stage of the procedure. The final result depends entirely on it.
Professionals are distinguished by the following characteristics:
- solid experience in the market;
- use of current technologies and techniques, modern software;
- availability of a functional and convenient Internet resource;
- a list of well-known partners who have already used the company’s services.
The specialists themselves who will conduct the assessment must have permits and insurance for your professional liability.
Step 2. We provide the necessary documentation
The appraisal firm will, of course, explain to you in detail what documents are required to be provided, but if you collect the package in advance, this will save time and immediately put the appraiser on a business wave.
Clients will need:
- title documents of the company;
- charter of the enterprise;
- registration certificate;
- list of real estate objects, property, valuable papers;
- accounting and tax reports;
- list of subsidiaries, if any;
- certificates of debt on loans (if there are debts).
The package is supplemented depending on the goals and features of the procedure.
Step 3. We agree on a business valuation model with the contractor
Usually the customer knows for what purpose he is conducting the assessment, but is not always aware of which methodology is best to use. During the preliminary conversation, the expert and the client jointly develop an action plan, determine assessment methods and agree on the timing of its implementation.
Step 4. We are waiting for the results of industry market research by experts
To begin with, appraisers need to analyze the situation in the industry segment of the market, find out current prices, trends and prospects for the development of the area under study.
Step 5. We monitor business risk analysis
Risk analysis – necessary stage business valuations. The information obtained during such analysis is necessarily used in drawing up the report.
Step 6. We control the determination of the development potential of the enterprise
Professional appraisers always take into account the prospects for business development, but it is advisable for clients to control this stage of the study and be aware of the results obtained. It is always useful to know what potential your business has.
Step 7 We receive a report on the work done
The final stage of the procedure is the preparation of the final report. The finished document is divided into separate positions and contains not only bare numbers, but also analytical conclusions. The report, certified by signatures and seals, has official force in resolving property disputes and in court proceedings.
How to conduct an assessment as competently and safely as possible for your company? Best option– engage independent lawyers as consultants at all stages. You can do this by using the services of the Pravoved website. The specialists of this portal work remotely and are available around the clock.
Most of the consultations on the site are free. However, if you need more in-depth assistance, the services are paid, but the amount of the fee is set by the customer himself.
5. Professional assistance in business valuation – review of TOP-3 valuation companies
Don’t have the time, desire or opportunity to look for an appraiser yourself? No problem - take advantage of our expert review. The three best Russian appraisers include the most reliable, competent and proven companies. Read, compare, choose.
It doesn’t matter for what purpose you are conducting an assessment - purchase and sale, secured lending, improvement of management, reorganization - KSP Group specialists will carry out the procedure professionally, promptly and in accordance with all the rules.
The company has been operating on the market for more than 20 years, has about 1000 regular customers, perfectly oriented in reality Russian business, provides free consultations to customers. Among the firm's regular partners well-known companies, small and medium-sized businesses.
The organization has membership in Self-regulatory organization ROO ( Russian society appraisers) and liability insurance for 5 million rubles.
The year the company was founded is 2002. The company guarantees prompt work (business assessment period is 5 days) and offers reasonable prices (40,000 for a standard assessment procedure). In its methods, the organization adheres to the principles of “Ethical Business” - transparency, honesty, openness, compliance with contract terms, responsibility.
Yurdis has 20 professional appraisers on its staff, members of the largest Russian SROs. Each of the specialists has liability insurance in the amount of 10 million rubles, diplomas and certificates confirming their high qualifications. Among the company's well-known clients are Gazprombank, Sberbank, Svyazbank, and the Military Mortgage Organization Center.
3) Atlant Score
The company has been doing business in the appraisal market since 2001. Works with tangible and intangible assets, develops and forecasts ideal schemes for increasing income, cooperates with enterprises in all regions of the Russian Federation.
The list of advantages includes benchmark accuracy of assessments, competent legal registration reports, a clear understanding of the goals and objectives of customers. The company is accredited by commercial and state banks of the Russian Federation, uses an expanded methodological base in its work, and applies its own technological and scientific developments.
And a few more tips on choosing the right appraiser.
Reputable companies have a well-designed and flawlessly functioning website. Through the Internet resource of such companies, you can get free consultations, order services, talk with managers and support representatives.
Conversely, fly-by-night companies may not have a network portal at all, or it may be designed as a cheap one-page website. No additional information, analytical articles, interactive features.
Tip 2. Refuse to cooperate with wide-profile companies
Organizations positioning themselves as universal firms do not always have the appropriate level of competence.
Business Cost Factors
If a person is able to evaluate an apartment or car himself, then when buying a business one cannot do without a qualified appraiser. And the point is not only that special knowledge will be required here, but also that information about the state of affairs at the enterprise must be correctly extracted and correctly interpreted.
In the shop ready-made business“They believe that the main factor in determining the value of an enterprise is its net profit, and not the accounting profit, but the money that the owner can withdraw from the enterprise.
1. “First of all, the buyer should pay attention to cash flows and net profit,” says Sergei Kharchenko, head of the valuation department of the Ready-Made Business Store.
If there is no profit even in management reporting, it’s worth thinking about it.”
According to expert observations, there is a discrepancy between “white” and “management” accounting in absolutely all enterprises. Of course, companies strive to operate as legally as possible. But even the smartest ones manage to bring no more than 80% of their business “into the white”.
2. Sergey Kharchenko considers the second most important indicator affecting the value of a business to be the period during which the business will generate money.
After all, products may lose relevance, competitors may appear offering a better product, lease agreements may expire, or the territory production premises They will plan to build an overpass, like in the movie “Garage”.
Business in leased territories is cheaper and “returns” faster, but has more risks associated with the unreliability of the lease.
If the business is done on its own premises and equipment, then it is more expensive and takes longer to complete. But equipment and especially real estate are themselves liquid assets. They can be sold at a profit even if the business collapses.
Intangible assets.
Experts differ in their assessment of such a phenomenon as goodwill - the intangible assets of a company consisting of a brand, business connections, employee talent, own know-how, etc.
For small businesses, of course, goodwill is not as significant as in large corporations that spend huge amounts of money on brand promotion.
The share of goodwill in the value of, say, a bakery is small, although it still exists - reputation, culinary skills, recipes.
But there are cases when goodwill makes up a significant part of the value of the business. For example, the value of a company developing software, fundamentally depends little on rented space or your own computers. In this case, the most important thing is bright minds, the names of developers and managers, as well as their connections.
In other words, the company may not have large tangible assets, the book value of its property will be small, but it is able to generate significant financial flows. This often applies to information and consulting businesses. Such companies are worth much more than the totality of their assets.
The difference between the selling price of a company and the price of its tangible assets is precisely the value of this very goodwill. The only catch is that it is extremely difficult to determine goodwill in any other way - except in the circumstances of the sale of the company.
Business staffing.
An important factor in the formation of goodwill, the overall value, and even the viability of the business is labor collective enterprise, its qualifications and controllability. The entire business can depend on one person, and this is a huge risk.
There is a known case in insurance business, When general manager sales manager left the company after the change of ownership, and 40% of clients left with him, that is, almost half of the business. He had enough to found his own insurance company.
But we're talking about not only about top managers who can move on to other concerns and take away clientele. No less serious problems are fraught with the whims of the main car mechanic, Uncle Vanya, with golden hands, on whom the entire car service business rests.
It’s funny, but the fate of a dry cleaner can be decided by a stain remover with a salary of 6 thousand rubles. The profession is very rare, and without such a specialist, dry cleaning loses both its meaning and clients.
Business valuation methods.
Appraisers use sophisticated techniques, the essence of which is simplified as follows:
1. Market method - an analysis of similar transactions on the market is carried out, the necessary discounts and allowances are made depending on the specific circumstances of the business, and thus the value of the enterprise that you want to buy is determined.
This is the method that everyone uses when buying a home or car - based on the prices for a similar product on the market.
2. Restorative method - the business is valued at the amount that would be required to develop a similar business from scratch.
3. Income method - in this case, the income that the enterprise gives or will bring is considered.
Here the assessment is influenced by the period during which it is possible to “recoup” the funds invested in the purchase. Nowadays, the payback period for an acquired enterprise is considered normal for small businesses and is equal to one and a half years.
No one will sell a running business for less than 7-8 months' profit.
It is rare that a business is sold for more than two to two and a half annual profits.
According to Alexander Butov, manager of the investment banking department of the FINAM investment holding:
First of all, the value of a business is determined by the company’s position in the market and its revenue
Next come profitability and accounts payable
The profitability factor is important - the forecast of cash receipts for the future and the period during which the acquisition can pay off.
But in practice, says Alexander Butov, buyers often use their naive methodology: revenue is multiplied by profitability and the number of years in which the new owner wants to recoup the deal.
For some reason, three years is considered a normal period.”
The procedure for transferring “business ownership”.
The most sensitive and difficult question is how to give away money and take ownership of a new business. I really want there not to be too much or even an insurmountable distance between these two acts.
It must be said that there are indeed risks here, including criminal ones. There are risks of non-compliance with agreements, deception - some intermediary firms even offer services to clients physical security. But, as the experience of recent years shows, fraud in this area is becoming less crude and more elegant.
The general trend is that everyone tries not to violate the law, especially criminal law. Which, however, requires even more diligence from intermediary consultants who monitor the purity of the transaction.
Director of the legal department of the “Ready Business Store” Sergei Samsonov lists the following as the main risks:
Hidden off-balance sheet obligations of the company being sold.
With some sales schemes, old debts that the previous owner managed to hide - for example, bills not taken into account on the balance sheet, some guarantees, guarantees - may come out after the transaction. And the new owner cannot get away from them;
The risk of non-fulfillment of obligations under a business purchase and sale transaction, that is, non-payment of money or non-receipt of rights to the business, with a competent intermediary with a good reputation is, in principle, reduced to a minimum.
A normal intermediary studies the credit history of the company and collects security information. Usually he is responsible for all documentation related to the appraisal - after all, he must have an appraiser's license.
In some cases, the intermediary may, by agreement with the parties, undertake financial guarantees for the transaction, but this is extremely rare.
Procedure for transferring money.
1. First, an agreement of intent is signed between the buyer and the seller, then the buyer hands it over to the seller against receipt or makes an advance payment to his account.
2. After this, all declared business circumstances are checked.
3. When the decision is made, the buyer opens a letter of credit in favor of the seller.
4. Then a purchase and sale agreement for 100% share or shares is signed, depending on the legal form of the enterprise.
5. The bank allows the seller to access the funds of the letter of credit only on the basis of a signed and certified purchase and sale agreement and registered in tax office new founding document.
Sometimes, instead of a letter of credit, the buyer rents a safe deposit box, which is used for payment using the same mechanism: the bank gives the seller access to the safe deposit box upon transferring to the buyer documents certifying his ownership of the business.
It's easy to transfer money.
Purchase and sale procedure
From a legal point of view, there are four forms of buying and selling a business.
1. The first and main thing is to replace the founders in an LLC or CJSC - as in a legal entity that owns a business. This is a fairly simple method.
Its disadvantage is that the legal entity retains its old credit history under the new owner.
Unknown off-balance sheet liabilities may surface.
There is also a significant advantage: replacing the founders does not require receiving the entire package permitting documentation, licenses, if the business is licensed.
You just need to register changes in the composition of the founders with the tax office.
The business seems to remain untouched, with its pros and cons. It's just that the founders and owners are different people.
2. The second method is to create a new legal entity and transfer to it assets associated with the purchased business.
Assets can either be sold or otherwise transferred.
When selling property from one legal entity to another, taxes naturally arise, which, however, can be minimized. The method is also simple, but also has a significant drawback.
The new legal entity must re-obtain the entire set of permits and licenses, if required. And this is a very troublesome matter.
According to experts, a couple of years ago it took three weeks to obtain all the documents for a beauty salon. A year later I had to spend five weeks. Now - almost three months. These are the results of the campaign to combat administrative barriers announced just two years ago. For three months, the finished enterprise will stand idle and incur losses for no business reason. Because of bureaucratic harassment.
Knowing the situation, mediator-consultants proceed as follows. They create a legal entity ahead of time and receive all the necessary documentation for it. This keeps downtime to a minimum. But in some cases it is impossible to obtain two permits for one case; you have to first disavow the old one and then wait for the new one.
3. The third form proposed by law is the sale of the enterprise as a property complex. But there are few such cases when an enterprise would be registered as a property complex.
On the contrary, often one legal entity has, for example, a car wash, two restaurants and a gas station, but only the gas station is sold.
Business purchase and sale transactions using this option occur extremely rarely. Although experts consider this method to be optimal, it practically eliminates all the risks described above associated with hidden off-balance sheet obligations or the need to obtain a bunch of new permits.
The three methods described are suitable for selling normally functioning enterprises. 4. There is a fourth one - for the endangered. This is a sale through liquidation. We are talking, of course, about friendly bankruptcy. Relatively speaking, the buyer and seller reach an agreement, the seller initiates the liquidation procedure of the enterprise, its property is described, sold at auction, where it is acquired by a new owner.
True, there is a risk that another bidder will come and beat the price. But experts say that if everything is done correctly, the transfer of the business to the right buyer is guaranteed. This mechanism is suitable for small, medium and large businesses.
Why are intermediaries needed?
The most important thing in this area is consultation, assessment, information, support. No sane investor would buy a business relying only on his own ingenuity.
The familiarity factor remains very important for Russian business. Both the buyer and the seller often need recommendations from third parties who are personally familiar with the parties.
A fairly large proportion of transactions go through without this. That is, a normal market situation becomes common, when the seller and buyer initially know nothing about each other.
The intermediary brings them together, helps with pre-sale preparation, often acts as a business consultant and helps clean up the business.
He also evaluates the enterprise, makes inquiries about high-level contracting parties in the interests of each of them, provides legal support and sometimes even resolves security issues.
The services of an intermediary consultant cost 2-15% of the transaction amount - all intermediaries emphasize that their approach is purely individual. Moreover, the seller pays for them.
The fact is that sales are carried out from the set of offers that is formed by the sellers, which is why the intermediary has to be paid. However, no one is stopping the buyer from paying for the services of an intermediary.
Taxes should also be included in the costs that arise during the transaction. A smart intermediary will, of course, help minimize them. The fact of buying and selling a business in itself is not an object of taxation.
Taxes arise if property is transferred during the transaction. Or if the business was sold by purchasing shares or shares and the purchase price exceeded the nominal value - this difference is considered the income of the seller and is subject to income tax - 13%, if we are talking about individual.
It is clear that in the case of an LLC, a 100% share of an enterprise can be valued at 10 thousand rubles at par of the authorized capital, but the business can cost $100,000. That is, the difference between the face value and the market price will be $99,700 and should be taxed as income to the seller.
Often the parties take legal risks, underestimating the formal value of the business, or agree to share the burden of taxes.
Now there are dozens and even hundreds of offers for the sale of a business on the market. Not only factories and ships are for sale, but also small enterprises that can be managed by an ordinary person with at least some business acumen.
This market may also be of interest to existing entrepreneurs who want to diversify their business.
Estimating a stock's fair value, or intrinsic value, is not an easy task, but it is useful for any investor to be able to do so to determine whether an investment is worthwhile. Financial multipliers such as Debt/Equity, P/E and others make it possible to evaluate the total value of shares in comparison with other companies on the market.
But what if you need to determine the absolute value of a company? To solve this problem, financial modeling will help you, and, in particular, the popular discounted cash flow (DCF) model.
We warn you: this article may require quite a lot of time to read and comprehend. If you now have only 2-3 minutes of free time, then this will not be enough. In this case, simply move the link to your favorites and read the material later.
Free cash flow (FCF) is used to calculate the economic efficiency of an investment, so investors and lenders focus on this indicator in the decision-making process. The size of free cash flow determines the size of dividend payments security holders will receive, whether the company will be able to fulfill debt obligations in a timely manner, and use money to repurchase shares.
A company may have a positive net income, but a negative cash flow, which undermines the efficiency of the business, meaning, in essence, the company does not make money. Thus, FCF is often more useful and informative than a company's net income.
The DCF model helps to estimate the current value of a project, company or asset based on the principle that this value is based on the ability to generate cash flows. To do this, cash flow is discounted, that is, the size of future cash flows is reduced to their fair value in the present using a discount rate, which is nothing more than the required return or price of capital.
It is worth noting that the assessment can be made both from the point of view of the value of the entire company, taking into account both equity and borrowed capital, and taking into account the value of only equity. The first uses the firm's cash flow (FCFF), and the second uses the cash flow to equity (FCFE). In financial modeling, in particular in the DCF model, FCFF is most often used, namely UFCF (Unlevered Free Cash Flow) or a company's free cash flow before financial liabilities.
In this regard, we will take the indicator as the discount rate WACC (Weighted Average Cost of Capital)— weighted average cost of capital. A company's WACC takes into account both the cost of the firm's equity capital and the cost of its debt obligations. We will discuss how to evaluate these two indicators, as well as their share in the company’s capital structure, in the practical part.
It is also worth considering that the discount rate may change over time. However, for the purposes of our analysis, we will take a constant WACC.
To calculate the fair value of shares, we will use a two-period DCF model, which includes interim cash flows in the forecast period and cash flows in the post-forecast period, in which it is assumed that the company has reached constant growth rates. In the second case it is calculated terminal value of the company (Terminal Value, TV). This indicator is very important, since it represents a significant share of the total value of the company being valued, as we will see later.
So, we have covered the basic concepts associated with the DCF model. Let's move on to the practical part.
The following steps are required to obtain a DCF estimate:
1. Calculation of the current value of the enterprise.
2. Calculation of the discount rate.
3. Forecasting FCF (UFCF) and discounting.
4. Calculation of terminal value (TV).
5. Calculation of the fair value of the enterprise (EV).
6. Calculation of the fair value of a share.
7. Constructing a sensitivity table and checking the results.
For analysis, we will take the Russian public company Severstal, whose financial statements are presented in dollars according to the IFRS standard.
To calculate free cash flow, you will need three reports: income statement, balance sheet and cash flow statement. Money. For the analysis we will use a five-year time horizon.
Calculation of the current value of an enterprise
Enterprise Value (EV) is essentially the sum of the market value of equity (market capitalization), non-controlling interest (Minority interest, Non-controlling Interest) and the market value of the company's debt, minus any cash and cash equivalents.
A company's market capitalization is calculated by multiplying its share price (Price) by the number of shares outstanding (Shares outstanding). Net Debt is total debt (specifically financial debt: long-term debt, debt due within a year, financial lease) less cash and equivalents.
As a result, we got the following:
For ease of presentation, we will highlight the hard data, that is, the data we enter, in blue, and the formulas in black. We look for data on non-controlling interests, debt and cash in the balance sheet.
Discount rate calculation
The next step is to calculate the discount rate WACC.
Let's consider the formation of elements for WACC.
Share of own and borrowed capital
Calculating the share of equity is quite simple. The formula is as follows: Market Cap/(Market Cap+Total Debt). According to our calculations, it turned out that the share of share capital was 85.7%. Thus, the share of debt is 100% -85.7% = 14.3%.
Cost of equity capital
The Capital Asset Pricing Model (CAPM) will be used to calculate the required return on an equity investment.
Cost of Equity (CAPM): Rf+ Beta* (Rm - Rf) + Country premium = Rf+ Beta*ERP + Country premium
Let's start with the risk-free rate. The rate on 5-year US government bonds was taken as it.
You can calculate the risk premium for investing in equity capital (Equity risk premium, ERP) yourself if you have expectations for the profitability of the Russian market. But we'll look at ERP data from Duff&Phelps, a leading independent financial advisory and investment banking firm whose estimates are followed by many analysts. Essentially, ERP is the risk premium that an equity investor receives rather than a risk-free asset. ERP is 5%.
The industry betas used were the emerging capital markets industry betas of Aswath Damodaran, a distinguished professor of finance at New York University's Stern School of Business. Thus, the unlevered beta is 0.90.
To take into account the specifics of the company being analyzed, it is worth adjusting the industry beta coefficient to the value financial leverage. To do this, we use Hamada's formula:
Thus, we find that the leverage beta is 1.02.
We calculate the cost of equity capital: Cost of Equity=2.7%+1.02*5%+2.88%=10.8%.
Cost of debt capital
There are several ways to calculate the cost of debt capital. The surest way is to take every loan the company has (including bonds issued) and add up each bond's yield to maturity and interest on the loan, weighing the shares of total debt.
In our example, we will not delve into the structure of Severstal’s debt, but will follow a simple path: we will take the amount of interest payments and divide it by the company’s total debt. We find that the cost of borrowed capital is Interest Expenses/Total Debt=151/2093=7.2%
Then the weighted average cost of capital, that is, WACC, is equal to 10.1%, given that we take the tax rate equal to the tax payment for 2017 divided by pre-tax profit (EBT) - 23.2%.
Cash flow forecasting
The free cash flow formula is as follows:
UFCF = EBIT -Taxes + Depreciation & Amortization - Capital Expenditures +/- Change in non-cash working capital
We will act step by step. First we need to forecast revenue, for which there are several approaches that broadly fall into two main categories: growth-based and driver-based.
Forecasting based on growth rate is simpler and makes sense for stable and more mature businesses. It is built on the assumption that sustainable development companies in the future. For many DCF models this will be enough.
The second method involves forecasting all financial indicators necessary to calculate free cash flow, such as price, volume, market share, number of customers, external factors and others. This method is more detailed and complex, but also more correct. Part of this forecast often involves regression analysis to determine the relationship between underlying drivers and revenue growth.
Severstal is a mature business, so for the purposes of our analysis we will simplify the problem and choose the first method. In addition, the second approach is individual. Each company needs to choose its own key factors influencing financial results, so it will not be possible to formalize it under one standard.
Let's calculate the rate of revenue growth since 2010, gross profit margin and EBITDA. Next, we take the average of these values.
We forecast revenue based on the fact that it will change at an average rate (1.4%). By the way, according to the Reuters forecast, in 2018 and 2019 the company’s revenue will decrease by 1% and 2%, respectively, and only then positive growth rates are expected. Thus, our model has slightly more optimistic predictions.
We will calculate EBITDA and gross profit based on the average margin. We get the following:
In calculating FCF we require EBIT, which is calculated as:
EBIT = EBITDA - Depreciation&Amortization
We already have a forecast for EBITDA, all that remains is to forecast depreciation. The average depreciation/revenue ratio for the last 7 years was 5.7%, based on this we find the expected depreciation. Finally, we calculate EBIT.
Taxes We calculate based on pre-tax profit: Taxes = Tax Rate*EBT = Tax Rate*(EBIT - Interest Expense). We will take interest expenses constant during the forecast period, at the level of 2017 ($151 million) - this is a simplification that is not always worth resorting to, since the debt profile of issuers varies.
We have already indicated the tax rate earlier. Let's calculate taxes:
Capital Expenditures or CapEx is found in the cash flow statement. We forecast based on the average share of revenue.
Meanwhile, Severstal has already confirmed its capital expenditure plan for 2018-2019 at more than $800 million and $700 million, respectively, which is higher than the volume of investments in recent years due to the construction of a blast furnace and coke oven battery. In 2018 and 2019, we will take CapEx equal to these values. Thus, the FCF ratio may be under pressure. Management is considering the possibility of paying out more than 100% of free cash flow, which will smooth out the negative impact of rising capex for shareholders.
Change in working capital(Net working capital, NWC) is calculated using the following formula:
Change NWC = Change (Inventory + Accounts Receivable + Prepaid Expenses + Other Current Assets - Accounts Payable - Accrued Expenses - Other Current Liabilities)
In other words, an increase in inventories and accounts receivable reduces cash flow, while an increase in accounts payable, on the contrary, increases it.
You need to do a historical analysis of assets and liabilities. When we calculate the values by working capital, we take either revenue or cost. Therefore, first we need to fix our revenue (Revenue) and cost (Cost of Goods Sold, COGS).
We calculate what percentage of revenue falls on Accounts Receivable, Inventory, Prepaid Expenses and Other Current Assets, since these indicators form revenue. For example, when we sell inventory, it decreases and this affects revenue.
Now we move on to operational liabilities: Accounts Payable, Accrued Expenses and Other current liabilities. At the same time, we tie accounts payable and accumulated liabilities to cost.
We forecast operating assets and liabilities based on the average indicators that we received.
Next, we calculate the change in operating assets and operating liabilities in the historical and forecast periods. Based on this, using the formula presented above, we calculate the change in working capital.
We calculate UFCF using the formula.
Fair value of the company
Next, we need to determine the value of the company in the forecast period, that is, discount the received cash flows. Excel has a simple function for this: NPV. Our present value was $4,052.7 million.
Now let’s determine the terminal value of the company, that is, its value in the post-forecast period. As we have already noted, she is very important part analysis, since it constitutes more than 50% of the fair value of the enterprise. There are two main ways to estimate terminal value. Either the Gordon model or the multiplier method is used. We'll take the second method using EV/EBITDA (last year's EBITDA), which for Severstal is 6.3x.
We use the multiplier to the EBITDA parameter of the last year of the forecast period and discount, that is, divide by (1+WACC)^5. The terminal value of the company amounted to $8,578.5 million (more than 60% of the fair value of the enterprise).
In total, since the enterprise value is calculated by summing the cost in the forecast period and the terminal value, we find that our company should cost $12,631 million ($4,052.7+$8,578.5).
Removing net debt and non-controlling interests, we get a fair value of share capital of $11,566 million. Dividing by the number of shares, we get a fair value of $13.8 per share. That is, according to the constructed model, the price of Severstal securities is currently overestimated by 13%.
However, we know that our value will vary depending on the discount rate and EV/EBITDA multiple. It is useful to build sensitivity tables and see how the value of the company will change depending on the decrease or increase in these parameters.
Based on these data, we see that as the multiplier grows and the cost of capital decreases, the potential drawdown becomes smaller. But still, according to our model, Severstal shares do not look attractive for purchase at current levels. However, it is worth considering that we built a simplified model and did not take into account growth drivers, for example, rising product prices, dividend yields significantly higher than the market average, external factors, etc. To present the overall picture of the company's assessment, this model is well suited.
So, let's look at the pros and cons of the discounted cash flow model.
The main advantages of the model are:
Gives a detailed analysis of the company
Does not require comparison with other companies in the industry
Defines the “internal” side of the business, which is associated with cash flows that are important to the investor
Flexible model allows you to build predictive scenarios and analyze sensitivity to changes in parameters
Among the disadvantages are:
Requires a large number of assumptions and projections on value judgments
Quite difficult to construct and evaluate parameters, for example, discount rates
A high level of detail in calculations can lead to investor overconfidence and potential loss of profits
Thus, the discounted cash flow model, although quite complex and based on value judgments and forecasts, is still extremely useful for the investor. It helps you dive deeper into the business, understand the various details and aspects of the company's operations, and can also provide insight into the company's intrinsic value based on how much cash flow it can generate in the future, and therefore bring profits to investors.
If the question arises about where this or that investment house got its long-term target (goal) for the price of a stock, then the DCF model is just one of the elements of business valuation. Analysts do much of the same work described in this article, but often with even more in-depth analysis and assigning different weights to individual key factors for the issuer as part of financial modeling.
IN this material We have only described a clear example of an approach to determining the fundamental value of an asset using one of the popular models. In reality, it is necessary to take into account not only the company's DCF valuation, but also a number of other corporate events, assessing the degree of their impact on the future value of securities.
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