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Business Valuation - Uses and Factors

 

Dr. A. Selvaraj

Assoicate professor - PG and Research Department of Commerce

Gobi arts and science college,Gobi, Tamilnadu, India.

 

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 India and abroad. At the core of the dynamics of all these activities stands some notion of valuation. The valuation methods are not only necessary for accounting purposes but they also serve as roadmaps for the angel investors, venture capitalists and corporate acquirers in order to know the true value of a company’s assets. 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.

 

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.