Katherine Broadhurst, Corporate Finance, Broomfield & Alexander
The 5th post in the series of Corporate Finance Insights sees Katherine divulging techniques of valuation.
Irrespective of what a formal valuation exercise tells you, the fundamental outcome is that a business is worth what a willing seller will accept and what a willing buyer will pay. The results of the formal exercise could bear no resemblance to the final “value” if there are special circumstances at play e.g. a special/strategic interest for the buyer or a pressure situation for the seller.
However, a formal exercise will provide a party with a rationale for the value they place on a particular company and the best valuations will consider a range of valuation methods before arriving at an estimation of a company’s “value”.
A key valuation technique is that of the earnings multiplier. Essentially, the multiplier is the number of years it is estimated it will take a buyer to get pay-back in profit terms on their acquisition cost.
When valuing an unlisted limited company, the multiplier is arrived at by considering the P/E (price/earnings) ratio of listed companies in the same sector. This is then discounted to take account of the key differences between listed and private companies, being size, product and service diversity and the ability to trade shares on an open market.
Historically, we professionals used the Private Company Price Index (PCPI) – a measure published by BDO Stoy Hayward of the multipliers published in relation to the sale of private companies and those for public companies. This enables us to calculate an average discount to apply to the published multipliers for listed companies when using it to calculate the earnings related value of a private company.
However, at the start of 2006, this discount reduced significantly and during 2008 and 2009 the figure actually turned negative, meaning that there were people out there prepared to pay more for private companies than they were prepared to pay for listed ones. This seemed ridiculous, but it was widely put down to being the result of the practices of private equity houses, their activities in aggressively growing their portfolios (with the readily available credit) and taking over whole public companies, thereby turning them private again.
For valuation professionals this meant that we could no longer use this industry measure as our discount factor, as the conditions resulting in the premium rather than the discount were not going to apply to the vast majority of the valuations we undertake in our day to day lives, much as we wished for our clients’ sakes that there were people out there prepared to pay over the odds for their business!
However, the resettling of the funding markets and the recession has cooled activity and provided the market with a period of reflection. Now that we are seeing the corporate finance market pick up again, the PCPI and its public company equivalent seem to have resumed their previous positions and a discount position has again been observed, approaching the levels pre-boom years. It will take some time for the averages taken over a period of time to return to previous levels, but at least we will again be able to use the industry standard to support our experience on the multipliers paid for private companies when it comes to valuations.
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