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Valuing shares in SME's
by Daniel Shear
In the current economic climate many small to medium sized unquoted businesses ("SME's") are looking for shareholders to inject some capital. But how does one value the price of the shares?
Valuation Concepts
Firstly the valuer ought to consider whether an owner, market or fair value is required. Briefly, owner value may be described as deprival value, that is what the owner would require to be deprived of the asset. Market value assumes a price is agreed in an open market between a willing buyer and seller trading at arm's length and is generally used in fiscal valuations. A fair value ascribes a value to an asset being traded that is fair between the parties to the transaction and therefore takes into account the relationship between the parties.
Owner, fair and market valuations could be very different, particularly in relation to the extent of discounting the value of shares held by a minority shareholder. To illustrate, a 15% shareholding in a company may well not correspond to 15% of the total value of the company, as the minority shareholder will not be able to exert any influence in the running of the company. The extent to which the value is discounted would depend on the composition of the remaining shareholders.
The company's articles of association or a shareholders' agreement may provide the answer. It is worth considering addressing this issue if signing a shareholders' agreement with a new investor.
Valuation Methodologies
There are a number of different valuation methodologies used to value SME's and often a combination of more than one approach will be used. The most common are:
- Discounted cashflow - the value of an asset is calculated as the present value of all the future expected cashflows earned by that asset (that is the future cashflows discounted back to today's monetary value). Although this is arguably the 'purest' way to value a company it is often too complex an exercise for SME's.
- Capitalisation of profits - also referred to as the price-earnings ratio method, this is the most frequently used method of valuing an SME. The price-earnings ("PE") ratios of listed companies are widely published and equate to the market capitalisation of the company divided by the company's post tax profits. Therefore a company's value can be expressed as a multiple of its profits. Further details are discussed below.
- Relative valuation - valuations are derived by comparing financial characteristics of businesses. The price-earnings ratio method is a relative valuation based on the post-tax profits. Other relative valuations often used are based on turnover, operating profit or EBITDA. Turnover valuations are generally used to value professional businesses that have a steady level of fee income. Other relative valuation methodologies are often not appropriate in valuing SME's but are more widely used in valuing larger companies.
- Asset based valuation - the value of all the company's net assets. This is generally best suited to asset heavy companies or companies that will not continue as a going concern (in which case a fire sale valuation of the assets would be most appropriate).
- Capitalisation of dividends - appropriate for valuing stakes in companies that pay regular dividends.
PE ratios
In valuing SME's using PE ratios it is important to assess the underlying maintainable earnings of the business and an appropriate capitalisation rate. The capitalisation rate will never be the same as the PE for quoted companies in similar industries as the shares in quoted companies are more liquid (they can be more readily sold for cash) and quoted companies are generally far larger and therefore often benefit from economies of scale. An appropriate rate of capitalisation can best be assessed by the judgment of an experienced professional valuer.
As noted above, once the value of the company as a whole has been deduced it is important to determine whether it would be appropriate to discount the shares held by a minority shareholder, or even apply a premium if the investment by one shareholder will enable him to take control of the company. Again, the articles or a shareholders' agreement may stipulate whether minority discounting should be applied. In the absence of such prior agreement the valuer would assess whether the company is being run as a quasi partnership.
In summary
It is crucial to remember that the price of any asset is determined by the marketplace. Therefore any valuation placed upon a business may not necessarily correspond to the actual price for which that business would change hands on a sale. This could be because the buying party is willing to pay a premium perhaps to secure a particular customer, or the seller may be willing to sell at a discount to facilitate a quicker transaction.
Valuations may sound very daunting. That's why we're here to help. BKL Corporate Finance has plenty of experience in valuing businesses for a variety of reasons. We'll advise you on the most appropriate valuation for your needs and undertake the valuation in an efficient manner.
For more information about how we can help you, please contact Daniel Shear.
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