Valuation is a versatile tool for decision-makers

Valuation is typically considered an exercise required only in M&A processes. In reality, valuations can serve various purposes in situations including large investments and development projects, financial arrangements, strategy formulation, changes of generation, portfolio analyses, incentive schemes, mergers and demergers, stock issue pricing and minority redemptions.

Professional owners monitor the value development of their company, steering operations with value drivers and placing them at the core of investment and operative decisions. Also non-professional owners should utilize valuations as strategic tools, integrating company value monitoring at the heart of their decision-making processes.

Valuation as part of M&A processes

Valuation is a necessary step in every M&A process to establish a basis for the selling price. Executed by independent experts, valuation provides the transaction parties a credible and reliable starting point for price negotiations. It is important to keep in mind, that the price is always buyer-specific and no such things as one “true” price exists. The transaction is closed only if the price of the seller and the price of the buyer meet. A carefully compiled valuation breaks down the value formation along with its bases.

Market capitalization (i.e. market value) is formed each day for companies listed in stock exchange. Yet, as not all investors agree on a company’s value, individual transactions may easily deviate +/- 20 % from the daily exchange rate. Similarly, in IPOs, some investors refrain from subscription due to high price while others hoard the cheap shares. These differences in value perception are visible also in market platforms exclusively for non-listed companies.

When selling or divesting a business, valuation can help determine a price point below which the seller should not engage in the transaction. Further, multiple valuations can be performed to estimate the maximum price point for individual buyers, as a company may have several values dependent on the buyer. For the buyer, the price is largely determined by attainable synergies which are usually buyer-specific. Closing the transaction is subject to reaching a price where the seller and buyer’s prices meet. This reflects the actual value of the company.

When acquiring a business, valuation can be also used to determine the maximum price for the buyer that can be paid without destroying the existing ownership value.

IFRS compliant accounting became requisite for listed companies in early 2005. Under IFRS, goodwill gained from acquisitions or items that hold goodwill in the balance sheet must be regularly tested for impairment. Tests must be carried out annually or if at risk of value loss. If the value of goodwill has impaired, the excess goodwill shall be written off as expense in the income statement.

In practice, goodwill test is a valuation performed as a part of an acquisition process, annually or more frequently in high-risk cases. As valuation methods have become increasingly standardized, understanding of valuations has also spread to IAS compliant companies which account for the majority of the Finnish company stock.

Valuation as a strategic tool

A company may identify multiple alternative paths to generate growth and boost profitability, including organic vs. inorganic growth, rapid vs. moderate growth, etc. When ready to assess and compare alternative growth paths, valuation provides a handy tool for decision-making.

Objective comparison between growth alternatives is challenging, if not carried out by unambiguous tools such as valuation. After company values are calculated for each individual growth path, explanations are required if deciding to proceed with any other than the highest value providing option. Higher risk lacks grounds as an explanation since the risk is already embedded in the calculations.

When outlining a portfolio strategy, valuation ensures the company’s limited resources are invested in targets that provide the highest value added. Business plans should be made for all business units, whose value added potential is measured through valuation. Value added potential measures the ability to increase ownership value. Traditionally the allocation of investment funds is based on historical performance which does not lead to optimal results in terms of company value.

When using valuation as a tool for the comparison of investment alternatives, the absolute completeness and perfection of starting values is not always vital. Even if starting values contained uncertainty, valuation can measure the change in value added.

Valuation process

Valuation can be made either as an in-house project or ordered from outside professionals. While the calculation models remain fairly simple and accessible to all, outside professionals hold a significant advantage over in-house departments in terms of experience and expertise. Additionally, outside professionals are trained to challenge the management’s views, providing fresh insights and discovering matters missed by the company. The valuation process can thus deliver valuable information for the management as a by-product.

In addition to gaining access to historical and current financial figures, valuation is ideally based on a carefully executed business plan along with numerical forecasts. Only then will the valuation be based on in-depth understanding of the company. On the other end of the spectrum, the so called ”quick and dirty” valuation method can be built on public data alone or performed in cooperation with the client. Valuation remains, however, only as reliable as its most unreliable assumptions. The more thorough the valuation process, the more reliable the results.

Our expert Martin Krokfors is happy to answer to your questions regarding valuations.

Martin Krokfors, Director, tel. +358 400 424 179  martin.krokfors@cag.fi

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