Investment bankers deal in the real world of MARKET VALUE. Market Value can be defined as the highest purchase price available in the marketplace for selected assets or stock of a company. But in my Market Value world, no value is established until a transaction takes place - a check is written, the contract for services and the earn-out (if part of the transaction - and it usually is) is negotiated and agreed to by all parties. Opposing parties often, in reality, value the earn-out and service agreements at remarkably different values, even though they have accepted the terms of the agreement, in some cases this aspect is discounted to zero. The seller has to accept an offer that meets his or her objectives which are not always purely financial. Rob Slee, author of Private Capital Markets and Midas Managers often states “Owner motives matter most” when addressing transactions in middle market businesses. We have reduced this to “OM3” in our practice. What this means is that owners influence the Market Value of the transaction through their motives. If you define motive as “a goal that initiates an action” then you can see how everything an owner does within his business influences Market Value.
Acquirers of businesses also have different motives and fall into several different value worlds. These include financial buyers, strategic buyers and a host of others and they all establish the value of a potential acquisition based upon their own particular motives and within their risk/reward criteria. This leads to a discussion of cost of capital and how it influences value, which we will discuss later in this series.
Businesses are often valued upon a multiple of EBITDA (Earnings Before Interest Taxes Depreciation and Amortization). Within a given industry and within companies of a given range of size, we always see a range of value. This is true whether the information comes from appraisers, from bids for companies by acquirers, or from published transaction data. Since there is always a range of value, based upon EBITDA, then there is more to value than just EBITDA. And this leads us back to motives.
Buyers will evaluate and establish a value for a company based upon financial information and upon the intangibles that they believe contribute to (or take away from) the value of the company. The business model creates the value of the company and the owner has the ultimate influence upon the business model due to his motives, so he has the ultimate say as to the value of his business.
The intangibles that acquirers of businesses place value upon, and the actions and initiatives that owners can take to increase the value of their businesses, will be discussed in the next segment of this series.
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