Source:
E-mail dt. 15.3.2012
Business Valuation - Uses and Factors
Dr. A. Selvaraj
Assoicate professor - PG and Research
Department of Commerce
Gobi arts and science college,Gobi,
ABSTRACT:
Business
Valuation has become an intrinsic part of the corporate landscape. The
corporate landscape has witnessed dynamic changes in the recent years as
mergers and acquisitions, corporate restructurings, and share repurchases are
happening in record numbers, both in
Key Words: Valuation- Mergers and
acquisitions-Factors-Investors.
INTRODUCTION
Business valuation is a process and a set of procedures used
to estimate the economic value of an
owner’s interest in a business. Valuation is used
by financial market participants to determine the price they are willing to pay
or receive to consummate a sale of a business. In addition to estimating the
selling price of a business, the same valuation tools are often used by
business appraisers to resolve disputes related to estate and gift taxation,
divorce litigation, allocate business purchase price among business assets,
establish a formula for estimating the value of partners' ownership interest
for buy-sell agreements, and many other business and legal purposes. A business valuation report generally begins with a
description of national, regional and local economic conditions existing as of
the valuation date, as well as the conditions of the industry in which the
subject business operates. A business valuation determines the value of a
business enterprise or ownership interest. A valuation estimates the economic
benefits that arise from combining a group of physical assets with a group of
intangible assets of the business as a going concern. The methods used for the
purpose usually depend upon purpose. The theoretical valuation arrived at has
to be perfected with market criteria, as the final purpose is usually to
determine potential market prices. By realising
significance of business valuation, this paper is an attempt to bring into
light the uses if business valuation along with factors influencing the
business valuation.
NEED
FOR BUSINESS VALUATION
In
the wake of economic liberalization, companies are relying more on the capital
market, acquisitions and restructuring are becoming commonplace, strategic
alliances are gaining popularity, employee stock plans are proliferating, and
regulatory bodies are struggling with tariff determination. The objective of
any management today is to maximize corporate value and shareholder wealth.
This is considered their most important task. A company is considered valuable
not for its past performance, but for what it is and its ability to create
value to its various stakeholders in future. Therefore, in analyzing a company,
it is not sufficient just to study its past performance. It is necessary to
understand the environment – economic, industrial, social
and so on – and its internal resources and intellectual capital in order to
gauge its future earning capabilities.
It
is therefore essential to understand that business valuation is important in
determining the present status as well as the future prospects of a company,
which in turn is important to understand how to maximize the value of a
company. The creation and development of corporate value is the single most
important long – term measure of the performance of a company’s management.
Further, this is the only common goal all shareholders agree on.
FACTORS
TO BE CONSIDERED IN BUSINESS VALUATION
Business
Valuation is a fascinating topic, as it requires an understanding of financial
analysis techniques in order to estimate value, and for acquisitions, it also
requires good negotiating and tactical skills needed to fix the price to be
paid.
*
Level of technology
*
Design and engineering
*
Material of construction.
*
Aesthetics
*
Features in a product, asset or business
*
Performance of an asset or business
*
Reliability
*
Maintenance and upkeep
*
Service features
*
Level of obsolescence of asset, or stage of
product in its life cycle
Apart from these factors some other factors
like The nature of the business and its
history from its inception, The economic outlook in general and the condition
and outlook of the specific industry in particular, The book value and the financial condition of
the business, The earning capacity of the company, The company’s earnings and
dividend paying capacity, Whether the enterprise has goodwill or other
intangible value, Sales of the stock and
the size of the blocks of stock to be valued,
The market price of the stock of corporations engaged in the same or a
similar line of business having their stocks actively traded in a free and open
market and The marketability, or lack
thereof, of the securities.
NEED
FOR VALUATION
All sorts of events could trigger a need for a valuation; so whenever major changes occur within the business discuss with check with the accountant or consultant whether valuation will be beneficial or required. Valuation may be required for the following purposes:
ü Disputing the
conclusions of regulatory investigation
ü Planning for
an initial public offering of company shares
ü Selling the
company or hiving off a division
ü Conducting a
major strategic-planning
ü Applying
for loan
ü Seeking
investors
ü Creating a
company stock-option plan
ü Breaking up a
partnership
ü Getting a
divorce
ü Liquidation
/Filing for bankruptcy
ü Doing estate
or gift planning that involves company stock.
Further, the purposes of business valuation may
be highlighted as follows:
The most common tax
purpose for a business valuation is to determine the value of a business
interest for federal estate and/or gift tax purposes. Business appraisers serve
as an objective third party that is able to determine the fair market value of
a company, which may include applicable discounts. The fair market value can
then be used by the client to determine their tax liability. Valuations for
estate tax purposes are subject to a constantly shifting body of laws,
regulations and court decisions. Valuations are required for purchase price
allocations of tangible and intangible assets under ASC 805 related to an acquisition of a
business. Valuations are also required
under ASC 360 to test for impairment of goodwill.
Shareholders in
closely-held companies do not always agree on the best course of action for a
company, or on a reasonable sale price should a shareholder wish to exit the
business. In this case, a formal buy-sell agreement may require an independent
business appraisal and baring an agreement it is always
needed to settle disputes on the value of the shares in question.
Business valuations provide business owners who are considering selling their
company with an objective opinion of value. Business valuations can also
provide all involved parties with peace of mind during a transaction, as final
values can either justify a buyer’s investment or cause them to reconsider.
When obtaining debt or
equity financing, often the lender or investor will obtain an independent
business valuation to validate their investment. For smaller business
interests, an SBA loan may be an option for debt financing. An independent
business appraisal is required for certain SBA loan packages. In the practice
of law, many different situations give rise to the need to establish the value
of a business. Some examples include: Drafting or assisting with implementing
buy-sell provisions in agreements between
and among shareholders, partners and limited liability company
members, business acquisitions and
mergers, change in business ownership or control among shareholders, business dissolution, litigation matters where a measurement of
economic damages is the diminution in the value of a business, bankruptcy matters and determining whether to
keep operating a business and/or sell it, or liquidate it, marital dissolution proceedings, condemnation proceedings, gifting for estate planning purposes and establishing values of a decedent’s estate.
SKILLS REQUIRED FROM CONSULTANT /PROFESSIONAL
ACCOUNTANT
In the last
few years, professional accountants have seen dramatic changes in accounting
rules, standards, regulation and corporate governance practice. This has
brought about sweeping changes to their traditional roles and requires them to
acquire new skills. One such area is business valuation. Hence, they have to
very seriously think of the following for real and genuine business valuation.
°
Understanding of the concept and purpose of professional valuation within
the accounting profession.
°
Knowledge of taxation aspects- tax on sale, gains, creating tax saving
entities.
°
Knowledge of Accounting standards related to
business combinations, intangible assets, employee options and financial
instruments.
°
Understanding of employee performance measurement criteria when valuation
is for stock options.
°
Awareness of issues impacting clients and ability to provide advice and direction to respond to
these issues.
SELECTION OF
CONSULTANT
While selecting the
consultant the organization should follow the procedures if any for engagement
of external consultant, applicable to the organization. Although, there might
be variations depending on need and purpose, the usual steps taken would be:
°
Determine whether the consultant has the
competence and experience to perform the engagement.
°
Determine whether the consultant has a conflict
of interest with the organization. Explore the situations or relationships which
might give rise to conflict of interest. A conflict could arise if the
consultant has a relationship with a member of the governing body or related to
the interested third party. Be aware of other potential conflicts of interest
that may distract, or undermine, the work to be done.
°
Determine if the consultant has sufficient
resources to perform the work in the time frame specified.
°
Consider Scope of work to be performed and other
issues, including the determination and plan for payment of fees and expenses.
°
Determine the criteria that will be used to
measure the consultant work and document those criteria in an agreement with
the consultant.
°
Decide on format of report and areas to be
included.
°
Since the consultant will have access to
business information, some of which will be confidential, the agreement should
include a confidentiality clause.
°
Determine the legal interest to be valued &
purpose of valuation.
CONCLUSION
If an independent
business valuation expert is called upon to assist in establishing a value
and/or opine on a value, the expert must have access to all relevant
information to determine which factors apply in the particular situation.
Certainly, the valuator has a responsibility to seek all information necessary
to do a thorough job, but all other parties involved have to be willing to do
valuation of business. When a business owner contemplates how to sell a
business, they often look for quick hit projects that will improve productivity
and, as a result, business valuation. To conclude, a valuation provides the
foundation for skilled business appraisers to estimate what your business is
worth. Valuation is frequently used in setting a price for an enterprise that
is being bought or sold. Professional valuations are now also being used by
financial institutions to determine the amount of credit that should be
extended to a company, by courts in determining litigation settlement amounts
and by investors in evaluating performance of company management. Lastly, a
valuation is often required under a variety of accounting and tax regulations.