The most common reason that a business acquisition does not proceed is the existence of a valuation gap, that is, the difference between what the purchaser is willing to pay for the business and what the seller is willing to sell the business for. Often, a seller has a rosier picture of the value of its business than the purchaser’s calculated value. It is helpful to understand the primary methods of valuation used to value a target. Of the three most common methods, one method uses just the target’s financial statistics to determine value. Depending upon the industry, the statistics measured will vary. The statistics might be a multiple of the target’s EBITDA, a multiple of the target’s discounted cash flow, a multiple of the target’s gross revenues or some other measure. The two most other common valuation methods take information from companies in the same industry as the target and apply it to the target’s finances to determine value. The “Guideline Company Transactions Method” examines metrics of sale transactions in the target’s industry and applies those metrics to the target’s finances. Using this method, most of the data comes from sales of publicly traded companies. The other method uses operating metrics of companies in the industry’s target, applying those metrics to the target’s finances. One or more of the three methods described above may be used, and if more than one method is used, they are typically weighted. By understanding the science (and art) of valuing companies, both purchaser and seller, if prepared, can come to the negotiation table with a more realistic chance of avoiding the valuation gap.
ABOUT GLENN D. SOLOMON
email@example.com | 443-738-1522
Glenn D. Solomon is a principal at Offit Kurman and has provided counsel to businesses and business owners for more than twenty-five years. He has extensive experience in the purchase and sale of businesses, structuring ownership agreements, and advising companies in financial distress.
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