There are a variety of valuation methods to determine the value of a company, including the net asset value, capitalized earnings value, discounted cash flow or comparative value method. Company values are subjective and reflect the interests of the valuer. Valuation methods vary in terms of the approach taken and their level of detail, resulting in a range of potential enterprise values. Therefore, it is common to use different valuation methods or a hybrid of several methods to obtain a fully comprehensive overview. Among the most widely used valuation methods for corporate transactions are the comparative value method and the discounted cash flow (DCF) method.
Company valuation on a comparative basis
The multiples methods use the valuations of listed competitors and purchase prices of past M&A transactions in the same industry to derive revenue, EBITDA and EBIT multiples. These methods are particularly popular with practitioners as they are simple and quick methods for determining market valuations. Here, the company’s sales, EBITDA or EBIT is multiplied by the average transaction or stock market multiples.
For a German industrial manufacturing company with sales of €30.0 million and EBITDA of €3.0 million, this would result in sales and EBITDA transaction multiples of 1.1x and 10.8x over the past 3 years. This results in an enterprise value of €33.0 million based on revenue and €32.4 million based on EBITDA. If the company were operating in a different industry with the same sales and EBITDA, the enterprise value would be the following values:
However, special attention must be paid to an adequate selection of suitable reference companies and reference transactions. Comparisons only make sense if the companies are of a similar size, operate in a comparable industry and have roughly similar margin and growth profiles.
The discounted cash flow method
The DCF method calculates the enterprise value on the basis of future payment surpluses – so-called free cash flows for distribution to shareholders or debt repayment – at the desired reporting date. The expected free cash flows are first determined for a detailed phase of 3 to 7 years in accordance with the corporate planning. Subsequently, a residual value of the company is determined at the end of the planning horizon, which is often determined using a perpetual annuity. The perpetuity is a permanent cash flow with a constant growth. Subsequently, the free cash flows in the periods of the detailed phase and the perpetuity are discounted with a discount factor (so-called WAAC, Weighted Average Cost of Capital) to obtain the present values, since 100 euros today are worth more than 100 euros in one year. The discount factor reflects the minimum returns on equity and debt.
A company that has free cash flows of 3.2 million euros, 3.1 million euros, 3.3 million euros and 3.4 million euros in this and the next three years would accordingly have an enterprise value of 40.0 million euros with a WACC interest rate of 10 percent and perpetual growth of 1 percent:
Although the DCF method can be used for all companies, it requires a high level of detail and is sensitive to small changes. A plausible forecast of cash flows (for a period of 3-7 years) as well as correct determination of the discount factor (WACC) is therefore essential. Your tax advisor or auditor as well as the team of Kloepfel Corporate Finance will be pleased to help you with a concrete calculation.
Due to the subjectivity of company values, there is no one correct valuation method for the sale of a company. Each valuation method offers specific advantages and disadvantages. Therefore, several methods of company valuation are usually applied in the sales process in order to obtain the most valid result possible.
If you are interested in an indication, the company value calculator on our homepage offers you the possibility to determine the value of your company without much effort.