Business valuation is a crucial step in both the sale and purchase of a company. Accurately determining the value allows for the establishment of a fair price while helping to avoid potential losses or disputes. Various approaches to valuation exist, each with its own nuances and suitable for different types of businesses. In this article, we will examine the primary methods of business valuation, the factors that can influence it, and a specific example of valuing the company Open Oil Market.
1. Business Valuation Methods
There are three primary approaches to valuing a company: the income approach, the comparative approach, and the cost approach. Each of these has its advantages and is applied based on the specifics of the business.
-
Income Approach:
- This method is based on forecasting the future income of the company and discounting it to the present value. The primary indicator used in this approach is the cash flows generated by the business.
- The Discounted Cash Flow (DCF) method involves estimating the future cash flows that the business will generate and bringing them to their present value, considering time and risk. This is one of the most widespread and accurate methods of valuation, particularly for companies with predictable cash flows.
- The Earnings Capitalization method is applied to companies with stable revenues, where profits can be projected into the future. Here, the current profit of the company is divided by a capitalization rate that takes into account the risks and growth rates of the business.
-
Comparative Approach:
- This method is based on comparing the assessed company with similar enterprises in the market.
- The Market Multiples method uses multipliers such as P/E (price-to-earnings), EV/EBITDA (enterprise value to earnings before interest, taxes, depreciation, and amortization), and others, allowing for valuation based on market data of comparable businesses. This method is especially popular in the sale of small and medium-sized enterprises.
- Comparison with similar transactions. If similar companies have recently been bought and sold in the market, their transaction terms can be used to evaluate the value of your company.
-
Cost Approach:
- This method is based on assessing the value of the company's assets, minus its liabilities.
- The Net Asset method determines the value of all company assets (e.g., real estate, equipment, intellectual property) and subtracts liabilities (debts and loans). The result is the assessed value of the business.
- The Liquidation Value method estimates the amount one would receive upon selling the company's assets in case of closure. This is the most conservative approach and is used in situations where the company is in crisis.
2. Factors Influencing Company Value
Numerous factors can influence a company's value, including both internal and external aspects.
-
Financial Indicators:
- Profit and Revenue. Companies with stable profits and growing revenues typically have a higher value.
- Debt Load. High debt can decrease a company's value as it raises risks for buyers.
- Profitability. A business with high profitability, demonstrating efficient resource utilization, is valued higher.
-
Market Conditions:
- Market Climate. Depending on the current market situation and trends in the industry, the value of a company can vary significantly. For example, during a crisis, buyers tend to adopt more conservative valuations.
- Competition. A high level of industry competition can negatively affect business value.
-
Quality of Management and Team:
- Key Employees and Leadership. Having an experienced and competent team can increase business value as it reduces risks for a new owner.
- Management Structure. If a business relies on a single owner or key employee, it may decrease in value, as the new owner risks losing valuable competencies.
-
Legal and Corporate Factors:
- Legal Structure and Licenses. Having the necessary licenses and legal permissions increases a business's value. Issues with legislation or ongoing litigations can decrease it.
- Contracts and Obligations. Contracts with major clients or long-term leases on favorable terms positively influence business valuation.
3. Example of Valuing Open Oil Market
The company Open Oil Market was assessed by the investment bank FINAM using the comparative method. The company OZON, one of the largest players in the Russian e-commerce market, served as a benchmark for the evaluation.
The valuation was based on multiples applied to companies of similar type and scale. The use of OZON as a benchmark was due to the similarities in business models, as both companies operate in platform markets, offering services to their clients through online platforms. This approach enabled a more accurate determination of the value of Open Oil Market, taking into account the dynamics of similar companies' development in the market.
4. Preparing a Business for Sale and Increasing Its Value
Preparing a company for sale is a crucial stage that can significantly influence the final price of the deal.
- Optimizing Financial Indicators. Ensure that your company's reporting is transparent and all financial indicators are in order. This includes reducing debt, improving working capital, and increasing profitability.
- Minimizing Risks. Resolve all legal and corporate issues before the sale. This may include settling any disputes, renewing key contracts, and obtaining necessary licenses.
- Investing in Development. Show buyers the growth potential of the business, for example, through new projects or market expansions.
- Optimizing Business Processes. Streamline internal processes and automate key operations. This will make the business more attractive to potential buyers.
5. Conducting Due Diligence When Purchasing a Business
Buyers typically conduct due diligence to verify the accuracy of provided data and identify potential risks. This includes:
- Financial Due Diligence. Analyzing the company’s financial statements to verify the claimed revenue, profitability, and debt burden.
- Legal Due Diligence. Reviewing legal documents including contracts, licenses, court cases, and intellectual property rights.
- Operational Due Diligence. Assessing the condition of production facilities, warehouses, technologies, and other company assets.
- Commercial Due Diligence. Studying market trends, customer base, competitive environment, and other external factors that may affect the future of the company.
Business valuation is a multifaceted process that requires consideration of numerous factors and the application of various approaches. The correct choice of valuation method and thorough preparation of the company for sale can significantly boost its value and make the transaction more profitable. The company Open Oil Market, which was valued using the comparative method with OZON as a benchmark, illustrates how multiples can be applied to assess the market value of platform businesses.
