Valuation – An overview

  • Valuation is the process of estimating worth of an item. Valuation is conducted usually to evaluate either a financial asset or liability. For business, valuation is done for the business as a whole to know the Networth of the company.
  • Valuation helps you to know the value of your business, to help you in pitching to prospective investors and other stakeholders. Valuation can be used as a very effective business tool by management for better decision making throughout the life of the enterprise.
  • An established business looking to go for the below, requires a valuation exercise
    • Pitching to prospective investors
    • Investment analysis,
    • Capital budgeting,
    • Merger and Acquisition transactions,
    • Joint ventures,
    • Buy sell agreements,
    • Inheritance or estate planning,
    • Financial reporting,
    • Determination of tax liability
    • For Litigation.
  • Businesses of new age, incur losses during their initial years say 2 to 3 years in hope that they will be able to capture market share and earn profit in future years. For such companies, valuation makes more sense in funding decisions than current financial statements. During investor pitches prospective investors want to know whether the company is capable of generating value for their money. In pitching sessions, the revenue generating model of the startup and its current valuation are two important factors. Especially for those businesses that face extreme uncertainty, the potential for substantial mispricing is high which clearly highlights the need for valuation expertise to create long-term shareholder value. Otherwise, they could be undermining their overall potential for creating value. A correct valuation of your business will highlight the shareholder value by investing in your business.
  • In going for an initial public offer or other equity offerings, knowing your post money valuation will let you know the amount of dilution you could expect after capital infusion forehand, so you can decide the amount of equity to offer to suit your dilution needs.
  • In the mature peak stages of business, both financial investors such as venture capitalists and entrepreneurs involved in a venture would ideally like to exit the venture in some form to maximize their return on investment. At this stage valuation helps determine the exit value of an enterprise at that peak. This exit value typically includes the tangible and intangible value of the company’s assets. Tangible value would typically include balance sheet items recorded as the book value of the enterprise.    Intangibles would typically include intellectual property, human capital, brand and customers, among others.
  • For business with many verticals, knowing the value of each vertical will help you in understanding how each vertical contributes to your overall value and identify non-value adding verticals and in selling the vertical will help in generating cash flows.
  • While there are hundreds of valuation models and metrics around, there are three major valuation approaches: 1) Intrinsic valuation (usually, but not always a Discounted Cash Flow (DCF) valuation) 2) Relative valuation 3) Contingent claim valuation (For assets having option characteristics).
  • Detailed client profiling is done to assess the suitability of the models referred.
  • Once the model is finalized, relevant data collection done from client and a detailed discussion is held on scope of the process and methodologies.
  • To explain one of the methods (DCF), Past data is collected and a detailed discussion session is held with client management to arrive at profit and loss and cashflow flow projection for coming years. Information is also gathered to factor the various cash flow movements within Operating, Investing and Financing activities over the projected years. Free cash flows are projected accordingly.
  • Subsequent steps involves estimating the Beta (Market Sensitivity), Discounting rate, terminal growth rate as relevant.
  • DCF valuation process culminates into arriving at a Value based on discounting the free cash flows, terminal value during the projected years.
  • In normal situations valuation is not done based on one methodology. Valuation is estimated based on multiple methods. A weight is assigned to each of the methods based on the suitability to the company’s business model. A Weighted valuation is done and considered as a Fair Value with a disclosed range.

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