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Are you looking for a consultant who will partner with you and conducts sound theory-based business valuations? Then you are right here. If a company is valued, uncertainty can either be compressed or unveiled. I simulate the company and its environment on thousands of possible paths. This allows getting a clear picture. Chances and risks are displayed as transparently as possible.
Business valuation is often summarised under the term Mergers and Acquisitions (M&A), but these are only two of four basic forms. It is subdivided into acquisition, sale, merger and demerger. In whatever of this situation you might find yourself in, I will support you during your transaction as an advisor. Speaking 14 languages I can partner with you, especially in an international context. If you want to find out more about me, consider reading the section “About me”.
Through a business valuation, the company value is calculated, which in a nutshell, reflects the benefit of the future cash flow to the shareholders. The most important company value in a business valuation is the decision value, which marks the limit to the advantageousness.
The decision value can be calculated by using a mathematical procedure (Operations Research) and is expressed as maximum price (acquisition), minimum price (sale), or quota (marginal rate) in the case of a merger and demerger. The calculated value is always individual.
It depends upon your financial situation. Your credit conditions, your tax situation and your withdrawal preferences count. If there is an intersection between the decision values of two parties, an impartial arbitrator can calculate an arbitration value. Apart from this, there is a value called argumentation value which is used to try to influence the counterparty. This classification is based on the approach of functional business valuation.
The following is a detailed overview of a business valuation. Valuation has a lot in common with consulting. The big difference is that in a valuation, the future has to be expressed precisely in numbers. A business valuation can be divided into the following steps.
The environmental and business analysis (and prognosis) are an essential part of a business valuation. Based on these, the balance sheet and profit and loss can be projected.
The environmental analysis can be split into two sections: the global environment and the task and competitive environment. The global environment is usually split up into five categories (Hungenberg, 2014):
Here it is important to filter out the relevant factors and projecting them. Because they can influence each other, I prefer not to use a tabular calculation program but a programming language. With this, I can easily include uncertainty and economic shocks. For example, the GDP per capita depends upon population growth, the investment ratio, the level of education and the GDP per capita of the prior year.
Next to the global environment, there is a task and competitive environment. Here the classification is done as proposed by Porter (1997) and Porter (1998):
A detailed explanation will not be conducted here.
The analysis of the business is usually divided using the functional approach (Hofer & Schendel, 1978):
or using the value-added approach (Porter, 2004; Scherm & Julmi, 2019; Barney, 1991):
In praxis, the above-mentioned concepts for analysing the business are difficult to systematically operationalise and should be more seen as a loose guideline. For analysing I fall back on methods of management accounting and balance sheet analysis. The conducted analysis serves as the foundation for projection. Of course, the projection has to take the intended strategy into account.
The acquired knowledge and projections from the steps above need to be applied to the company. A usual way of doing this is projecting the future balance sheets and profit and loss for a chosen planning horizon, like five or ten years. For this I use the in Data Science appreciated programming language Julia in which I created a simulative accounting package. Simulative means that not point values, but bandwidths with probability distributions, are estimated.
Is it possible to say that the revenue for a certain product in two years will be 500.000€, or is it more genuine to say that the revenue will be 500.000€ with a standard deviation of 25.000€? Additionally, the costs of sales are about 50%, but cannot be exactly calculated and fluctuate about 3%. In the simulation, thousands of accountings are booked in parallel. (The same is true for the environmental projection.) Because thousands of scenarios are simulated, chances and risks are made visible at a significant level.
For getting a better understanding of how a simulation works, in figure 1 a (fictive!) price index is displayed, which grows yearly by 2% and has a coefficient of variation of 1%. Figure 2 shows a fictive profit distribution of a company. Every path of the simulation is consistent in itself.
Figure 1: Fictive Price Index
Source: Own diagram.
Figure 1: Fictive Profit Distribution
Source: Own diagram.
Methods for business valuation transform the future cash flow to the shareholders by discounting into the company value, which itself reflects the future benefit to the shareholders. The main methods for business valuation are 1. the approach of functional business valuation, 2. the capitalised earning method and 3. the DCF-method.
Business valuation is vital for answering questions like ‘What is the value of my/this company?’ or ‘What is a reasonable price for the acquisition or sale of this company?’. An enumeration of all possible methods is not intended here, but I will mention an amazing book by Matschke and Brösel (2013).
However, some methods should be explained in more detail:
The approach of functional business valuation is used for calculating the company value, which is called decision value. The cash flow is discounted by so called-endogenous marginal interest rates, which depend on the valuation subject.
Functional business valuation distinguishes three main functions: the decision function, the mediation function and the argumentation function. They are connected to each the decision value, the arbitration value and the argumentation value. The decision function is used to find a value where the transaction is still acceptable and not adverse.
Next, the mediation function serves to find a compromise between the given parties. The decision value of each party serves as the starting for a fair compromise in the process of price determination.
Last, the argumentation function is important for negotiations. Argumentation values are calculated with the intention to influence the other party.
When calculating the decision value your situation is important, to put it in other words your tax situation, your credit conditions and your withdrawal preferences matter. The decision value will be calculated using (non-)linear optimisation. Think of a financing plan or a spreadsheet which takes all your cash flows and tax rates into account. To make it short, your finances are optimised to the last cent.
The capitalised earning method is a method for business valuation and is used for calculating the company value, whereas the future cash flow is discounted by a tax-corrected interest rate. The value should reflect the benefit of the cash flow to the shareholders.
The roots of the capitalised earning method and functional business valuation are the same (endogenous marginal interest rates), however, it’s simplified. The future cash flow is discounted using a tax-corrected interest rate. Depending on the model’s modification, a risk premium is added.
However, the capitalised earning method is often associated with the capitalised earning method from IDW. This variation left its former roots. Now it focuses on an objectified value of a business which corresponds to the argumentation value of the functional business valuation (Matschke & Brösel, 2013). In a nutshell, the personal situation is largely ignored. If one calculated a financing plan before and after the transaction, it would become clear that the company value calculated by the capitalised earning method from IDW is not a marginal price (decision value). Normally, the withdrawal should be the same in both, even if other cash flows change because of the transaction. The reason is that the capitalised earning method from IDW is a value calculated for a fictive situation. The interest rate is derived from a model called TAX-CAPM and adjusted by a risk-premium (beta-factor).
Risk is compressed and not unveiled. Unveiling it, for example, by simulating various possible paths, chances and risks are made visible at a significant level. Remember that in an M&A-transactions important decisions, with huge impacts are taken. If requested, this value is calculated for reasons of argumentation.
Discounted-Cash-Flow (DCF) is a generic term for different methods (APV, WACC, FTE) for business valuation. In a nutshell, the future cash flow (profit distribution) to the shareholders is discounted by a risk-adjusted interest rate and expressed as the company value.
They are build upon the basis of the equilibrium theory of Modigliani and Miller (1958) and a model called CAPM (Sharpe, 1964; Lintner, 1965; Mossin, 1966), or one of its modifications. Three methods/approaches should be mentioned here:
The adjusted present value (APV) approach is based on the equilibrium theory. The value of a company is composed of a basic cash value and a tax shield. Liabilities, different from equity, are tax-privileged. The starting point is the gross free cash flow which contains the profit distribution and interest payment to creditors. Through easy mathematics, return on equity can be calculated in retrospect (!). The return on equity serves as interest for discounting the free cash flow. In praxis, the return on equity is derived from a model called CAPM (or one of its modifications), even if the assumptions of both models are not compatible (Hering 2021).
The weighted average cost of capital (WACC) approach is not based on the equilibrium theory. The free cash flow is discounted with the average cost of capital. This is composed of the cost of equity (expected return on equity) and the tax-corrected cost of capital. Both are weighted according to the relation of each equity and liabilities in relation to the total capital. Again in praxis, the return on equity is derived from the model CPAM. The interest is composed of a base interest rate plus risk-premium (beta-factor).
The equity approach (FTE) is based on the equilibrium theory and CAPM. Here, the free cash flow is discounted by the expected return on equity.
All three mentioned approaches can be converted by transformation under the presumption that the expected return on equity is the same.
Without going too much into the theoretical details, it should be mentioned that those values are easy to calculate but lack validity. If financing plans are set up, the discrepancy is clearly seen. What does a fictive objective company value matter, if it is not corresponding to your personal financial situation now and in the future? One might for example derive a base interest rate of 2% and a risk-premium of 3% from a model. However, your bank only offers you 6%. What importance does a tax rate in a model matter if it’s not yours and your rate might be even progressive. Those values will differ from your decision value. For this reason, they should be used only for argumentation in negotiations.
The valuation itself will be conducted using Jupyter-Notebook and you receive the report as PDF file. Jupyter-Notebook is a kind of interactive word processing program, in which you can also code (model). The advantage is that the valuation can be comprehended by both of us step by step. Not only this, but it’s also possible to adjust certain aspects easily. If there are new proposals during negotiation, they can be integrated easily. Examples are that the property now should only be rented but not sold or that adverse information is withheld until the end.
Hering, T. (2021). Unternehmensbewertung (4. ed.). De Gruyter Oldenbourg.
Hofer, C. W. & Schendel, D. (1978). Strategy Formulation: Analytical Concepts. West Publ.
Porter, M. E. (1997). Competitive Strategy. Measuring Business Excellence, 1(2), 12–17.
Porter, M. E. (1998). Competitive Strategy: Techniques for Analyzing Industries and Competitors. Free Press.
Porter, M. E. (2004). Competitive Advantage: Creating and Sustaining Superior Performance. Free Press.
Scherm E. & Julmi, C. (2019). Strategisches Management. De Gruyter Oldenbourg.
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